(1) The version of Mises in Human Action: A Treatise on Economics (Auburn, Ala., 1998), pp. 568–583.It should be noted that ABCT is not monolithic. But the historical essence of the theory is fairly clear:
(2) Hayek’s first version of ABCT in Prices and Production (London, 1931). After Nicholas Kaldor’s attack on it in “Capital Intensity and the Trade Cycle” (Economica n.s. 6.21 (1939): 40–66), Hayek had to re-write his theory.
(3) Hayek’s second version of ABCT in Profits, Interest and Investment (London, 1939).
(4) M. Skousen’s new interpretation in The Structure of Production (New York, 1990).
(5) Gerald P. O’Driscoll and Mario J. Rizzo in The Economics of Time and Ignorance (Oxford, UK, 1985), pp. 198–213.
(6) More recent developments of ABCT, as in Roger Garrison’s Time and Money: The Macroeconomics of Capital Structure (London and New York, 2000).
“ABCT is unique in including real capital goods among its elements in a manner which does not assume away their essential heterogeneity ... The theory demonstrates the connection between this structure of capital and monetary policy by way of Wicksell’s natural rate of interest theory and Mises’s integration of money into general economic theory” (Batemarco 1998: 216)However, both Ludwig Lachmann and Joseph Schumpeter did not think that Hayek’s business cycle theory could be used to explain all business cycles (Batemarco 1998: 222). More importantly, Israel M. Kirzner has also made the following remarks on Hayek’s theory:
KIRZNER: I've never felt that the Hayekian business cycle theory was essentially Austrian. In fact, Mises, who was the originator of this whole idea in 1912, didn't see it as particularly Austrian either. There are passages where he notes that people call it the Austrian theory, but he says it's not really Austrian. It goes back to the Currency School and Knut Wicksell. It's certainly not historically Austrian. Further, I would claim that, as developed by Hayek, there are many aspects of it that are non-Austrian. I don't believe that to be an Austrian you have to buy into the Hayekian view of business cycles …. I think the way Hayek developed it was not quite consistent with the way Mises laid it out in 1912 (see “An Interview with Israel M. Kirzner,” Austrian Economics Newsletter, vol. 17.1, 1997).Kirzner believed that Hayek’s own version of ABCT was “not quite consistent” with Mises’ own theory from his 1912 book The Theory of Money and Credit. So clearly we have to careful about which form of ABCT we are criticising.
In this post I will analyse what appears to me to be the most important form of ABCT: the form postulating distortions in the capital goods sector (for a good summary of this form of ABCT, see Garrison 1997: 23–27), and how this simply cannot be invoked as a serious or fundamental explanation of the US housing boom in the 2000s and financial crisis of 2008.
In his popular pamphlet Economic Depressions: Their Cause and Cure written in 1969, Rothbard sets out a form of ABCT which seems typical of the general form of it . He points to malinvestments in capital goods by businesses as the fundamental cause of recessions:
“And there is a third universal fact that a theory of the cycle must account for. Invariably, the booms and busts are much more intense and severe in the “capital goods industries”—the industries making machines and equipment, the ones producing industrial raw materials or constructing industrial plants—than in the industries making consumers’ goods” (Rothbard 2009 [1969]: 32–33).In this short book, Rothbard says nothing about reckless lending by banks to people for mortgages, nothing about asset bubbles, and nothing about financial crises. The crisis that Rothbard postulates begins with a bust in “producers’ goods industries.” Rothbard also discussed ABCT in Man, Economy, and State (2004 [1962]: 994–1008). In a most extraordinary passage in Man, Economy, and State, Rothbard says this:
“But what happens when the rate of interest falls, not because of lower time preferences and higher savings, but from government interference that promotes the expansion of bank credit? …. What happens is trouble. For businessmen, seeing the rate of interest fall, react as they always would and must to such a change of market signals: They invest more in capital and producers’ goods. Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable now seem profitable, because of the fall of the interest charge. In short, businessmen react as they would react if savings had genuinely increased: They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods” (Rothbard 2009 [1969]: 32–33).
“The problem comes as soon as the workers … begin to spend the new bank money that they have received in the form of higher wages. For the time-preferences of the public have not really gotten lower; the public doesn’t want to save more than it has. So the workers set about to consume most of their new income, in short to reestablish the old consumer/saving proportions. This means that they redirect the spending back to the consumer goods industries, and they don’t save and invest enough to buy the newly-produced machines, capital equipment, industrial raw materials, etc. This all reveals itself as a sudden sharp and continuing depression in the producers’ goods industries. Once the consumers reestablished their desired consumption/investment proportions, it is thus revealed that business had invested too much in capital goods and had underinvested in consumer goods” (Rothbard 2009 [1969]: 34–35).
“What happens, however, when the increase in investment is not due to a change in time preference and saving, but to credit expansion by the commercial banks? …. What are the consequences? The new money is loaned to businesses.110 These businesses, now able to acquire the money at a lower rate of interest, enter the capital goods’ and original factors’ market to bid resources away from the other firms. At any given time, the stock of goods is fixed, and the [new money is] … therefore employed in raising the prices of producers’ goods. The rise in prices of capital goods will be imputed to rises in original factors. The credit expansion reduces the market rate of interest. This means that price differentials are lowered, and … lower price differentials raise prices in the highest stages of production, shifting resources to these stages and also increasing the number of stages. As a result, the production structure is lengthened. The borrowing firms are led to believe that enough funds are available to permit them to embark on projects formerly unprofitable.After this, Rothbard (2004 [1962]: 996–1004) expounds ABCT in its usual form. But his footnote has profound significance: “[to] the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur.” In other words, the mechanisms causing recession or depression as postulated by his version of ABCT did not occur if the money is mainly loaned to consumers! ABCT assumes that newly created credit money is mainly loaned out to businesses (causing malinvestments in capital goods), and not to consumers to a significant degree.
[footnote]
110 To the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur. (Rothbard 2004 [1962]: 995–996).
In this case, we can already see that Rothbard’s version of ABCT cannot be a serious explanation of the housing bubble in the 2000s and the financial crisis of 2008.
It is claimed by some that Austrians economists predicted the crisis, and while it is true that some Austrians correctly identified the housing bubble, they were hardly alone. J. Tempelman in the Quarterly Journal of Austrian Economics states
“[to] be sure, a financial crisis of sorts had also been forecast by many non-Austrian economists, such as Nouriel Roubini and Stephen Roach ... [William R. White] and other Austrians, on the other hand, were more precise in predicting that a crisis would be triggered by a collapse of an asset bubble, specifically the real estate bubble” (Tempelman 2010: 5).The idea that Austrians were the only ones holding a “more precise” view just isn’t true. There were also heterodox and Post Keynesian economists who were just as “precise” as some Austrians in predicting a financial crisis caused by a housing bubble and excessive debt. The most obvious example is the Post Keynesian Steve Keen of the University of Western Sydney (Australia), who from 2006 was predicting a major financial crisis (see Steve Keen, “‘No-one saw this coming’ Balderdash!” July 15th, 2009, Debtwatch.com).
Moreover, Dirk Bezemer, Professor of Economics at the University of Groningen (Netherlands), has also done a survey of economists and economic commentators trying to establish who predicted the crisis by looking at those with (1) a serious economic model that was used in analysis, (2) predictions that went beyond identifying the property bubble to the implications for the real economy, (3) predictions on the public record, and (4) correct estimates of the timing of the crisis (see Dirk Bezemer, “‘No One Saw This Coming’: Understanding Financial Crisis Through Accounting Models,” Groningen University, 16 June 2009). Here is Bezemer’s list:
Forecast date: 2005Now of these eleven commentators and economists:
Fred Harrison, UK, Economic commentator
Forecast date: 2006
Dean Baker, US, Co-director, Center for Economic and Policy Research (in August 2002, he also appears to have predicted the housing bubble);
Michael Hudson, US, Professor, University of Missouri;
Steve Keen, Australia, Associate professor, University of Western Sydney;
Jakob Brøchner Madsen, Denmark, Professor, Copenhagen University;
Robert Shiller, US, Professor, Yale University;
Nouriel Roubini, US, Professor, New York University;
Kurt Richebächer, US, Private consultant and investment newsletter writer;
Forecast date: 2007
Wynne Godley, US, Distinguished scholar, Levy Economics Institute of Bard College;
Eric Janszen, US, Investor and iTulip commentator;
Peter Schiff, US, Stock broker, investment adviser and commentator.
(1) Five (45%) are Post Keynesians (Baker, Godley, Hudson, Keen, Sorenson);So in other words eight (72%) of the eleven made accurate predictions about the bubble and crisis and were non-Austrians. The largest group (45%) were actually Post Keynesians.
(2) Two (18%) are basically maverick neoclassicals (Roubini and Shiller);
(3) Two (18%) are in the Austrian tradition (Richebächer and Schiff).
(4) One (Fred Harrison) calls himself as a Georgist (a follower of Henry George)
(5) One is a combination of Austrian and Post Keynesian (Janszen).
(on the classifications, see Barkley Rosser, J. “Did Heterodox Economists Do Better At "Calling It" Than Mainstream Ones? August 28, 2009).
The claim that Austrians were the only ones to predict the crisis of 2008 is pure nonsense. Moreover, just because some Austrians correctly called the housing bubble, it simply does not follow that ABCT has been vindicated. Many other economists from different schools also called the housing bubble and a financial crisis. Are we, for example, to say that because Fred Harrison correctly predicted a housing bubble that his actual Georgist economics is therefore proven right? This simply does not follow, nor does it follow that Austrian economics is correct, merely because some Austrians identified the housing bubble as Harrison did.
In 2001–2008, excessive debt and reckless lending to individuals in a system of ineffective financial regulation was a major factor. This has nothing to do with entrepreneurs making malinvestments in capital goods that shift output into the more remote future, as in ABCT.
In the housing bubble, loans were made to people who clearly were unlikely to pay them back. Debt was used bid up asset prices in property, allowing yet more debt (via refinancing) for purchasing of commodities (whether durable or non-durable). ABCT in the form examined above does not explain this process. Another fundamental factor in the crisis of 2008 was the emergence of exotic financial instruments like collateralised debt obligations (CDOs), including asset backed securities and mortgage backed securities.
When the housing bubble collapsed, defaults on mortgages rose, causing losses to investment banks and other financial institutions holding mortgage backed securities. The financial crisis of 2008 led to a freezing up of interbank lending and a liquidity crisis, which then went global. The resulting effects spread to the real economy severely exacerbating the US recession that had already begun in December 2007. This series of events is best explained by the Keynesian Hyman Minsky’s financial instability hypothesis.
ABCT in the form examined above with its emphasis on malinvestments in the real capital goods sector is not an even remotely relevant explanation of 2000s boom and bust, and the 2008 global financial crisis.
BIBLIOGRAPHY
Batemarco, R. J. 1998. “Austrian Business Cycle Theory,” in P. J. Boettke (ed.), The Elgar Companion to Austrian Economics, Elgar, Cheltenham, UK. 216–336.
Cowen, T. 1997 Risk and Business Cycles: New and Old Austrian Perspectives, Routledge, London.
Garrison, R. W. 1997. “Austrian Theory of Business Cycles,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia, Garland Pub., New York. 23–27.
Garrison, R. W. 2000. Time and Money: The Macroeconomics of Capital Structure, Routledge, London and New York.
Hayek, F. A. von, 1931. Prices and Production, G. Routledge & Sons, Ltd, London.
Hayek, F. A. von, 1935. Prices and Production (2nd edn), Routledge and Kegan Paul.
Hayek, F. A. von, 1939. Profits, Interest and Investment, Routledge and Kegan Paul, London.
Hülsmann, J. G. 2001. “Garrisonian Macroeconomics,” Quarterly Journal of Austrian Economics, 4.3: 33–41.
Kaldor, N. 1939. “Capital Intensity and the Trade Cycle,” Economica n.s. 6.21: 40–66.
Kaldor, N. 1940. “The Trade Cycle and Capital Intensity: A Reply,” Economica n.s. 7.25: 16–22.
Kaldor, N. 1942. “Professor Hayek and the Concertina-Effect,” Economica n.s. 9.36: 359–382.
Kirzner, I. M. 1994. Classics in Austrian Economics: A Sampling in the History of a Tradition, William Pickering, London.
Lachmann, L. M. 1978.Capital and its Structure, S. Andrews and McMeel, Kansas City.
Mises, L. von, 1953, The Theory of Money and Credit (trans. H.E. Batson), J. Cape, London.
Mises, L. 1996 [1949]. Human Action: A Treatise on Economics (4th rev. edn), Fox and Wilkes, San Francisco.
Mises, L. 1998 [1949]. Human Action: A Treatise on Economics, Ludwig von Mises Institute, Auburn, Ala.
Rothbard, M. N. 2004 [1962]. Man, Economy, and State: A Treatise on Economic Principles, Ludwig von Mises Institute, Auburn, Ala.
Rothbard, M. 2008 [1985]. What has Government done to our Money? Ludwig von Mises Institute, Auburn, Ala.
Rothbard, M. 2009 [1969]. Economic Depressions: Their Cause and Cure, Ludwig von Mises Institute, Auburn, Ala.
Schumpeter, J. A., 1939. Business Cycles (2 vols), McGraw-Hill, New York.
Skousen, M. 1990. The Structure of Production, New York University Press, New York.
Sraffa, P. 1932. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.
Tempelman, J. 2010. “Austrian Business Cycle Theory and the Global Financial Crisis: Confessions of a Mainstream Economist,” 13.1: 3–15.
Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition, Cambridge University Press, Cambridge and New York.
I said it on the other thread on Say's Law and I will say it here again for clarity. My response is simple. House-flipping makes a house a 1st order capital good.
ReplyDeleteBefore you respond to my previous comment, please remind yourself that in economics, a "good" is not the physical thing but the services it renders.
ReplyDeleteThe fundamental cause of the crisis was defaults by subprime mortgage holders.
ReplyDeleteThese people were not "house flippers": the significant factor was subprime mortgages that went bad made to occupant-owners or subprime mortgages made to occupant-owners used to refinance existing loans.
" the significant factor was subprime mortgages that went bad made to occupant-owners or subprime mortgages made to occupant-owners used to refinance existing loans. "
ReplyDeleteEven in this case, the houses were not consumption goods. The house was treated as the source of the present good - money. You cannot say that people who bought a house banking on appreciation to take more loans to repay old loans can be called pure consumers. The house has become the "future good" that generates the "present good" (money) and is hence a first order capital good.
That apart,
" These people were not "house flippers" "
Claims. Claims. Claims. No substance.
My simple point is that the crisis was born out of the choice of treating a house as a producers' good of the first order. Once you make this small shift, everything else follows as per ABCT.
Subprime certainly was a part of the story, but no market can continue to double every few years while the rest of the economy dribbles along at 2% growth. The mathematical reality is that, eventually, that market would comprise nearly the entire economy. Obvious distortions of the markets have to explode.
ReplyDeleteThe people who invested in homes during the bubble market were banking on the greater fool theory, the ones who owned at the bust were the greatest fools.
The expansion of the housing market was fueled by low interest rates and easy credit, pretty much classic ABCT. There was a tremendous amount of malinvestment in the housing industry that absolutely needed to bust. In California, the average price of a home was $500,000 and the average wage was $50,000. Expansionary credit and easy money was certainly the fundamental driver of the boom, and the bust was the necessary and inevitable result.
The same basic pattern could be seen in the stock market bubble of the nineties, and the mortgage bubble of the 1980s, for the same reasons. They were just a different markets experiencing the bubbles.
The excessive debt and reckless lending you mention have everything to do with the housing bubble. Most people were not buying homes in rapidly appreciating localities primarily to house their families. They were entrepreneurs investing in what they considered a very safe, rational investment, house prices only go up, right? The investment in homes in this sense is not a consumer's good, even if they happened to live in them with their families. They were very serious investment assets, and the high and increasing prices lured builders to overbuild to a huge extent, as would be expected under ABCT.
When the imbalance became too obvious for anyone to ignore, the house of cards came crashing down. The bigger the boom, the bigger the bust. Pure ABCT.
The further complications of derivitives can also be analyzed with the same logic. They were different but related markets. They were, however, driven by interest rate manipulations by the Fed, along with a knowledge of the big banks that they would be able to socialize the losses if their risky plans backfired. They obviously were correct in that assumption.
Dan McLaughlin,
ReplyDeleteYou say:
The expansion of the housing market was fueled by low interest rates and easy credit, pretty much classic ABCT.
And where exactly do you think "classic" ABCT is described (in what book of, say, Mises)?
"Classic" ABCT appears to me to be the exposition in Rothbard I have just quoted above. That is laughably irrelevant to the 2000s bubble.
If you are just saying that "low interest rates and easy credit" were ONE factor that led to a bubble, there is nothing uniquely Austrian about that - plenty of Keynesian economists have said the same thing. The key point you miss is that it was all done in a severely flawed system of financial regulation.
In the 1945-1970 period, there were plenty of years when "low interest rates and easy credit" occurred in numerous countries around the world. But no devastating housing bubbles and financial crises erupted, because financial markets were properly regulated back then:
http://socialdemocracy21stcentury.blogspot.com/2009/11/financial-deregulation-and-origin-of.html
Rothbard:
ReplyDelete[businesses] invest more in capital and producers’ goods. Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable now seem profitable, because of the fall of the interest charge ... They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods” (Rothbard 2009 [1969]: 32–33).
People taking out liars loans or NINJA loans were NOT making investments, particularly in lengthy and time-consuming projects they were buying houses already built on *secondary* markets.
" People taking out liars loans or NINJA loans were NOT making investments, particularly in lengthy and time-consuming projects they were buying houses already built on *secondary* markets. "
ReplyDeleteMost laughable. Rothbard's statement "investments, particularly in lengthy and time consuming projects...." should be seen in the context of home-builders who were producing 2nd order producers' goods for the consumers' goos manufacturers, i.e., the sub-prime borrowers, the NINJA loan takers, house flippers, etc who used the "investment" in the house as their means of producing consumer goods, i.e., money.
" They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods” "
Yes. Sub-prime borrowers, NINJA loan takers, House flippers, etc expanded their investment in durable equipment/industrial raw material called houses in order to produce present goods (money) or even producers' goods for producers of the next lower level, i.e.,sub-prime borrowers, NINJA loan takers, house flippers, etc who in turn...... heaven knows how many cycles it took before it reached a real consumer of the house.
In fact, going by my previous paragraph, Rothbard's statement can be applied to anyone except those who bought homes SOLELY for consumption.
p.s. Houses can be industrial raw material in the same sense that freshly distilled wine can be the raw material for the process of maturation of wine. The $100,000 house would soon (or so they thought when they bought) mature into a $200,000 house and I can get my $100,000 for being smart enough to take a loan at $100,000. The greater fool theory that Dan McLaughlin spoke of makes it even more macabre.
who used the "investment" in the house as their means of producing consumer goods, i.e., money.
ReplyDeleteYou have pretty much shot yourself in the foot. You think money is a *consumer good* (= commodity)??
Logically, you are committed to the view that only commodities are wealth, which means you must logically concede (on this view) that money (modern fiat money, no less!!) is wealth.
Rothbard's statement can be applied to anyone except those who bought homes SOLELY for consumption
And there were any number of such people. There were the subprime mortgage holders who were owners-occupiers.
Lord Keynes,
ReplyDeleteAnother event happened in the 1970's that might have some bearing on inflationary credit expansion. The "closing of the gold window" freed the United States government to inflate with impunity by repudiating all ties of the dollar to gold.
Whether you look at that as good or bad, it definitely was a watershed event. The reason that the last tie to gold was severed was because gold put a limit on the rate at which the government could increase spending and devalue the dollar. If they devalued too much, foreign governments would simply trade dollars for gold. After closing the window, there was no such limitation on the manipulation of money and interest.
Exactly what is laughably irrelevant about what Rothbard said in the quote? It is far from obvious from your discussion. You seem to assume that housing is purely consumer spending in all cases, thus refuting what Rothbard said regarding the relationship between consumer and producer goods. The investment in housing certainly wasn't for pure consumption goals, but, at least in rapidly inflating markets, rather primarily for investment goals, which fits very well the same logic that Rothbard used for investment in production goods. When a tractor is used to produce income, it is a production good, a higher order good. If that same tractor is purchased for plowing one's driveway in the winter, it is a consumption good, a first order good. The physical nature of the good is not what is important.
What is important is that investment spending is diverted into what otherwise would not attract investors. We saw a massive building spree as contractors tried to get a piece of the pie. It became unsustainable.
In the 2000s, people diverted spending from consumption goods to buy ever more expensive homes as an investment. They were certainly production goods in the sense that they were expected to produce a profit sometime in the future. They did not serve merely as a domicile.
That diversion of spending and the distortion of the housing market had all of the marks of mal-investment. The artificially low interest rates leading up to it and the expanding credit showed all of the marks of an unsustainable boom.
What individuals from whichever school of thought called the bubble and bust is really irrelevant. The important thing is that the people in charge of the money and credit and government spending certainly did not see it, or were lying to the people. They wore the rose-colored Keynsian glasses and said everything was wonderful until after the bust occurred. Bernanke gave solid reassurance to the market just before it collapsed.
What I am saying, and I believe that the ABCT asserts, is that there cannot be a sustained massive bubble in a market without massive inflationary credit. If there is a sustained bubble, it arises, necessarily, from excessive credit expansion from below market interest rates. The monetary distortions are the sin-qua-non of bubble markets. Regulatory issues can certainly affect the results, but they are not the cause.
Here is a graphic illustration of mal-investment in the housing market. ABCT in full color from 2009.
ReplyDeletehttp://www.youtube.com/watch?v=ZsgOaCZ2Lag
After closing the window, there was no such limitation on the manipulation of money and interest.
ReplyDeleteThis is incorrect. Central banks still determine interest rates, just as they did in the Bretton Woods era. Credit and debt was limited by financial regulation even after the gold window closed. It only began to be dismantled in a serious way by Reagan, with the beginning of the neoliberal bubble era in severely flawed deregulatory bills like the “Depository Institutions Deregulation and Monetary Control Act” (1980) and the “Garn–St. Germain Depository Institutions Act” (1982). The Savings and Loan crisis that resulted was related to these acts. Clinton’s abolition of Glass–Steagall was a serious mistake too.
In the 2000s, people diverted spending from consumption goods to buy ever more expensive homes as an investment
No, they took out loans and went into excessive debt to finance consumption – that was the fundamental issue.
They were certainly production goods in the sense that they were expected to produce a profit sometime in the future
They were not “capital goods” in any reasonable sense of that term in relation to owner occupiers: these were people who went into debt, bought a home to live in, and then expected to make money from capital gains on their asset (the home) appreciating in price. We are talking about assets and asset bubbles, not production goods.
They wore the rose-colored Keynesian glasses and said everything was wonderful until after the bust occurred
Nope. They wore neo-liberal glasses like Greenspan, the ex-Ayn rand acolyte
What I am saying, and I believe that the ABCT asserts, is that there cannot be a sustained massive bubble in a market without massive inflationary credit.
Which is exact what any other school will also tell you – this is not some unique insight of Austrians.
" You think money is a *consumer good* (= commodity)?? "
ReplyDeleteOops!!! I meant to say present good. I missed out correcting this one bit while I went about correcting it elsewhere in the same comment. Note that in my second paragraph, I have referred to money as a "present good". I didn't realise that I had used the word "consumer good" elsewhere too. Sorry about the error. Change it to "present good" and I am sure it will make sense.
" And there were any number of such people. There were the subprime mortgage holders who were owners-occupiers. "
Technically speaking, borrowers do not own the mortgaged asset till the loan is fully repaid. Leaving the legalities aside for the moment, there is a more fundamental economic issue you are missing. These were (and are) "sub-prime" borrowers. That means "people without the income to repay the loan". If they didn't have the income to repay the loan, clearly, they were banking on an appreciation in the price of the home so that they could bail out or refinance at that point. Until that time, they could enjoy the house in any case.
So, your attempt at using the phrase "owner-occupier" to try to imply that sub-prime borrowers were engaging in pure consumption is truly laughable.
I'm sorry. The sub-prime borrowers, NINJA loan takers, home flippers, etc were using houses as a capital goods employed for the purpose of earning money from the appreciation in its capital value. Try as you might, but you can't slime out of it.
And that means the sub-prime crisis was PRECISELY as Rothbard described it.
" Nope. They wore neo-liberal glasses like Greenspan, the ex-Ayn rand acolyte "
ReplyDeleteA man is to be judged by his actions. Not by his claims. Greenspan ceased to be a "neo-liberal" and an "Ayn Rand acolyte" the moment he accepted the job of Fed Chairman.
" Which is exact what any other school will also tell you – this is not some unique insight of Austrians. "
The only difference is that Austrians also explain WHY it happens and what needs to be done to eradicate the scourge of the business cycle.
Central banks still determining interest rates, but when there was the threat of a massive exodus of gold from the U.S. government due to devaluation, there was a very real limitation that they could not get around. Regulation or no regulation, the effective limit on money creation and devaluation gave the government less flexibility to inflate at will while that threat was still effective.
ReplyDeleteThe bubble economy was in real estate and related instruments in the 2000s. There was certainly consumer debt, which complicated the issue, but mortgage foreclosures of properties, the value of which decreased to less than the face value of the mortgage, was the real issue. Borrowers were under water because they bought homes in a tremendous bubble, caused by an artificial low interest rate policy, easy credit and monetary inflation. If there was a massive bubble in real estate, that necessarily means that spending was diverted from somewhere. That somewhere was consumer spending. If there was no real estate bubble, there would have been massive consumer price inflation. The only reason there wasn’t was because money was diverted to investments in real estate.
Homes certainly are “capital goods” to the extent that the transaction was entered into for investment or speculative reasons, regardless of who actually lives in the house. That seems to be the heart of our disagreement. It really is, however, a matter of semantics. Whether a house is called a capital good or a consumer good only matters to the extent that it can help us understand the reality. It is, from my perspective, unquestionable that many, if not most, people bought houses in rapidly rising markets for speculation and investment, hoping to cash in through a future sale or from taking cash out through refinancing later. The name is not important. The investment nature is what makes it fit the ABCT structure.
In talking about Greenspan, you would be right if he actually lived by what he said in the sixties. When he became Fed chairman, he repudiated everything he espoused in the earlier days. He was a politically driven money manipulator.
What the ABCT does assert that other schools ignore or contest, is that bubbles have consequences, in the form of mal-investment, the actual destruction of wealth, value and production, and that the government is ultimately responsible for all bubbles. Other schools don’t recognize the mal-investment and assume that if government just pumps things up enough, everything will get back to normal. This is obviously false, as the video I posted earlier shows. There is real destruction of wealth because the artificial stimulus used too many scarce resources for ventures that could not be profitable, whether those ventures were factories, machines, or houses which can’t be sold.
The other part of the paragraph that you quoted from my last response was “If there is a sustained bubble, it arises, necessarily, from excessive credit expansion from below market interest rates. The monetary distortions are the sin-qua-non of bubble markets.” I can tell you that the present monetary authorities certainly don’t believe that, whatever school of thought they subscribe to. They continue to distort the money supply and interest rates, and government continues to make it difficult for business to anticipate the future, to prevent prices from falling to the market levels, and to squeeze out private sector investment with its continual “stimulus.”
Thanks for this great discussion, but I really need to go to bed.
ReplyDeleteAll the best,
Dan
I'm sorry. The sub-prime borrowers, NINJA loan takers, home flippers, etc were using houses as a capital goods employed for the purpose of earning money from the appreciation in its capital value
ReplyDeleteRegrettably, this simply won't work. If you earn money from "the appreciation in [sc. a house's] capital value" then this is speculation on asset prices, NOT obtaining an income through production and a sale of commodities.
Therefore the home cannot be, and is not, a capital good.
The only difference is that Austrians also explain WHY it happens and what needs to be done to eradicate the scourge of the business cycle.
I am afraid not. Asset price speculation and damaging asset bubbles can happen under a gold standard and a free banking system (for how it happened in Australia in the 1880s, see C.R. Hickson and J.D. Turner, 2002, “Free Banking Gone Awry: The Australian Banking Crisis of 1893,” Financial History Review 9: 147–167.
Even if you implemented your fantasy libertarian world, with no FRB or fidicary media under a commodity standard, money could STILL flood in through the capital account from overseas, causing bubbles. These things are driven by irrational investor expectations, you don't need a central bank or FRB as necessary conditions to make them happen.
Dan McLaughlin,
ReplyDeleteThanks for your contribution.
" Even if you implemented your fantasy libertarian world, with no FRB or fidicary media under a commodity standard, money could STILL flood in through the capital account from overseas, causing bubbles. "
ReplyDeleteI guess money could keep flooding in from overseas forever, can't it? I guess they are discovering mountains of Gold and Silver every year somewhere in the world except in the country you are referring to, aren't they? I see ancient Mercantilist fallacies creeping into your arguments.
Even if money were not to "flood" in but just keep coming in every year, what makes you think it would be available for "irrational asset market speculation"?
" These things are driven by irrational investor expectations, you don't need a central bank or FRB as necessary conditions to make them happen. "
Utter nonsense. No FRB/Government Intervention in the monetary system/Central Banks - No bubbles. At least, no bubbles characterissed by wide-spread malinvestment in producers' goods industries.
" If you earn money from "the appreciation in [sc. a house's] capital value" then this is speculation on asset prices, NOT obtaining an income through production and a sale of commodities. "
Nonsense again. If I am speculating on asset price increases and buy in order to get the asset price increase, I am very much in the business of buying and selling the asset. Hence, the asset becomes the "capital good" in the business. It is my "inventory". That I do not modify it actively to transform it into something else does not make it any less of a capital good.
The home buyer waiting for an asset price increase is no different from the wine maker waiting for his wine to mature before selling it. Neither wants to consume the good but only to sell it when conditions are right. The house is as much a producers' good to this home buyer as the maturing wine is to the wine
producer.
Just a straight question - Is Walmart's inventory part of its capital or are those consumption goods? Are the soaps and detergents in Walmarts warehouses and shelves producers' goods or consumption goods?
You still seem to be failing to realise that in economic terms, the word "good" does not stand for the physical thing but for the services it provides. To the home owner speculating on a price increase, the home provides the service of generating additional money, the ultimate "present good" with which he can go for his preferred consumption goods. Since the home is used largely for the purpose of making available present goods, it is a producers' good.
If I am speculating on asset price increases and buy in order to get the asset price increase, I am very much in the business of buying and selling the asset
ReplyDeleteBut you are NOT in the business of producing commodities. And that is where the analogy fails.
(1) The occupier of a house is NOT producing commodities. If he does what you say, if he buys the house, lives in it and sells at a higher price, he’s a speculator on asset prices. He just happens to have an asset whose value is appreciating because of a bubble.
The house is not “producing” commodities (goods and services) for sale – it is not a capital good.
(2) Even when a person buys the house and flips it without living in it (or renting it), he is not owning a capital good either. He has an asset whose value he is speculating on. He expects a capital gain. That may not happen. The house is not producing any commodities for sale.
This is similar to owning a financial asset: I have an asset and expect its value to rise, and I can make money if it does rise by selling it.
Neither the house nor the financial asset is a capital good.
" Neither the house nor the financial asset is a capital good. "
ReplyDeleteInvestments do not constitute consumption goods either. So your point is incorrect in any case.
" The occupier of a house is NOT producing commodities. If he does what you say, if he buys the house, lives in it and sells at a higher price, he’s a speculator on asset prices. "
You still don't get it. The point is not what a thing is or what a person does with it but the satisfaction that it provides. That is the economic definition of the concept "good" that you are still busy evading.
There is a world of difference between buying a house for the purpose of consumption and then finding at a later date that I am better off selling it than living in it and buying a house for the purpose of further re-selling it solely to reap the benefit of the capital value appreciation. If the latter, it is not a present good. It is a future good that can generate a present good (money). The "use" here is "holding" just as much as storing wine in barrels waiting for it to mature is.
Incidentally, you are yet to refute the similarity between "holding" a house and "storing" wine till it matures or Wal-Mart's holding inventory till it is sold. In each case, the person holding it has no intention to "consume" it.
"The satisfaction that a thing provides" can only be understood by understanding the motivations that drove the very purchase of a thing. If I buy solely to live in it, the house is a consumption good. If I buy it as th means to get future goods (money in the future), it cannot be called a consumption good.
If it cannot be called a consumption good because it is not a present good and it provides the holder with future goods, what do you call it?
Further, the issue is not just what a house "is" but what the people who were buying houses "treated it as". While I will agree that a house is basically a consumers' good, the crisis was brought upon by people treating what is basically a consumers' good as a producers' good.
What makes a house a speculative investment that can become a "producers' good" for wannabe home-flippers is essentially cheap credit (to enable them to buy it) and significant increases in home prices in reasonably short durations (made possible by the massive monetary pumping engaged in by the banking system). From 2001 to 2007, that's precisely what the banking system did. The cheap credit and tsunami of money transformed otherwise ordinary people into businessmen engaged in home-flipping. Thus was a consumers' good transformed into a producers' good.
You seem to have a serious problem of not being able to see capital markets as part of the economic system. Very Keynesian indeed.
ReplyDeleteThe point is not what a thing is or what a person does with it but the satisfaction that it provides.
ReplyDeleteThis is a bizarre statement – the essence of a capital good/producer’s good is precisely
a thing which is used in production to produce other goods and services, rather than for final consumption. What is done with it is a fundamental part of its definition.
than living in it and buying a house for the purpose of further re-selling it solely to reap the benefit of the capital value appreciation. If the latter, it is not a present good. It is a future good that can generate a present good (money)
But it is not a capital good. What commodity are you “producing” by buying an asset and holding for the expected capital gain? None.
Incidentally, you are yet to refute the similarity between "holding" a house and "storing" wine till it matures or Wal-Mart's holding inventory till it is sold.
It’s easily refuted:
(1) Holding a house to sell it later on the expectation of a capital gain involves NO production of commodities. The house is an asset.
(2) The wine IS a commodity being produced in the final stages of production; The capital goods of the winemaker are his vats and other materials. Your bizarre analogy would require the winemaker to hold his vats (as a capital good and asset) idle, produce no wine, and just wait for an expected capital gain in the price of his vat. If he did this, he is not producing anything, and has become himself a speculator on asset prices (in this case his capital good).
(3) Walmart’s is already a business: it provides a retail service. The house is NOT producing any such service or good.
" Walmart’s is already a business: it provides a retail service. The house is NOT producing any such service or good. "
ReplyDeleteThat Walmart is already a business is absolutely irrelevant. Walmart is in the business of making goods available at a particular place at a particular time. It is an intermediary in the process of distribution. The home-flipper is an intermediary in the process of home sales. There is no essential difference. It just so happens that the home-flipper's goods are immovable. That does not makes them any less of inventory.
If Wal-Mart's inventory is their "producers' good", the home-flipper's "home-to-be-sold" is a "produers' good' too. There is no difference between the 2 situations and therefore no scope for different treatment.
" What commodity are you “producing” by buying an asset and holding for the expected capital gain? "
ReplyDeleteFirst define what is "producing". In this case, the home flipper is "producing" a house in a particular place the buyer wants it in at the time the buyer is in a position to and wishes to buy it.
Walmart is in the business of making goods available at a particular place at a particular time. It is an intermediary in the process of distribution.
ReplyDeleteAbsolutely right.
The home-flipper is an intermediary in the process of home sales.
And these are real assets on secondary markets - they are not commodities that the owner has "produced" and the houses are not producing commodities either (the essence of the definition of a producers' good).
The home owner is not in the *business* of "house sales" and as one agent involved in these asset transactions he clearly very different from an actual business like Walamrt.
The home owner is just one owner of an asset wanting to sell that asset to someone else on a *secondary* market.
" the essence of a capital good/producer’s good is precisely a thing which is used in production to produce other goods and services, rather than for final consumption. "
ReplyDeleteOf course. I am just saying that for the home-flipper, the home is not a consumption good. It is the means to get the consumption goods he desires.
And it is his business to flip homes to generate the money he needs for this.
His customer may be the ultimate consumer of the home, but the home-flipper is not applying the house in consumption.
Take another case. If I have a house that I have let out on rent, is it a producers' good or a consumers' good?
"producing" = act of production
ReplyDeleteproduction = creation by factor inputs of commodities for exchange
in this case, the home flipper is "producing" a house in a particular place the buyer wants it in at the time the buyer is in a position to and wishes to buy it.
No, he isn't engaged in "production" of houses. He owns a real asset that was "produced" prior to his resale.
He is no more engaged in production of houses than someone who sells an old book at a second hand book store or fair to someone else.
These are sales on secondary asset markets.
" Absolutely right. "
ReplyDeleteBut Wal-Mart DID NOT produce these goods. They just buy what someone else produces and makes it available at a particular place at a particular time.
Similarly, the home-flipper did not produce the house. He just buys what someone else produces and makes it available at a particular place at a particular time.
There is NO difference.
" The home owner is not in the *business* of "house sales" and as one agent involved in these asset transactions he clearly very different from an actual business like Walamrt. "
As I have shown above, there is NO difference.
" He owns a real asset that was "produced" prior to his resale. "
ReplyDeleteThat, while of course true, is not the relevant factor here. What matters is his making it available when and where the buyer wants it, just as Wal-Mart does.
" He is no more engaged in production of houses than someone who sells an old book at a second hand book store or fair to someone else. "
Oh!! So making things someone else has "produced" available at a different place and/or time is not production, is it?
" These are sales on secondary asset markets. "
ReplyDeleteSo according to your theory, a used-car salesman is not producing anything, is he?
A used car is as much a consumers' good as a new car is. In fact, it is so much of a consumers' good that new cars have to compete with used cars for customers. Push new car prices high enough and a lot of people will shift to used cars. People will even enter the market as sellers of used cars.
Nuff sed
ReplyDeletehttp://mises.org/daily/3894
The article ("Is Housing a Higher-Order Good?") is interesting, makes valid points, but refers to *newly constructed* houses only:
ReplyDelete"Human resources especially were directed away from producing consumer goods and services towards the development of housing projects."
He completely neglects to mention that the bubble included houses *already constructed* and bought and sold on secondary markets. This was an asset bubble in the existing stock of houses too.
Also, he provides no support whatsoever for your view that houses bought by flippers are a "capital good". On the contrary, he admits that they are a durable consumer good.
This is incompatible with your views above.
None of his analysis explains refinancing of mortgages by people *already living* in a house, or subprime loans to people who bought on secondary markets.
Subprime loans are "consumer loans" not loans made to businesses investing in higher order capital goods.
To the extent that easy credit caused excessive construction in housing by construction firms, he is right.
But this is only part of what was going on. It was reckless lending to people who couldn't repay debt that caused the subprime meltdown. Also, financial innovation and securitization is not explained by ABCT. The financial crisis was caused by CDOs that went bad, that set off a crisis in overleveraged investment banks and a liquidity crisis.
As I have said above, Minsky's financial instability hypothesis does a far better job of explaining this.
Regarding the difference between home sellers and businesses:
ReplyDelete(1) home sellers, people selling books to second hand book shops are not engaged in commodity production.
(2) Second hand car dealers, real estate agents are all producing a real service: you confuse the sellers of second hand assets (houses, books, cars) who provide no service and are not producers with the service businesses that facilitate these exchanges of assets on secondary markets.
" As I have said above, Minsky's financial instability hypothesis does a far better job of explaining this. "
ReplyDeleteMinsky's FIH is explanatory but fundamentally false because it assumes that Capitalism is fundamentally unstable. It ignores the point that it is fiat money and particularly FRB+Central Banking that causes the instability.
Minsky's FIH is explanatory but fundamentally false because it assumes that Capitalism is fundamentally unstable.
ReplyDeleteMaybe you should read something about it:
http://en.wikipedia.org/wiki/Hyman_Minsky
It assumes that financial markets are inherently unstable.
http://blog.mises.org/14283/putting-austrian-business-cycle-theory-to-the-test/comment-page-1/#comment-732747
ReplyDelete" It assumes that financial markets are inherently unstable. "
ReplyDeleteI said the same thing. I only added that this assumption is fundamentally false. So, Minsky's FIH is meaningless.
Sorry I’m late to this party!
ReplyDeleteCouple things Lord Keynes, if I may…
Considering you know Mises is the fountainhead of the “Austrian” version (which is a “mere elaboration” in his own words) of the old Monetary Theory of the Trade Cycle, why critique Rothbard instead of Mises?
Have you not read what Mises wrote about circulation credit theory in 1923 & 1928?
These works were (finally) translated into English in the early 1970s and published in “The Causes of the Economic Crisis.” As the editor Percy Greaves Jr. wrote in the introduction (in 1977):
“Mises was then writing at a time when such credit expansion was primarily in the form of discounting short term (not longer than 90 days) bills of exchange. Consequently, such loans were always business loans. The first consequence was always a bidding up of the prices of certain raw materials, capital goods, and wage rates, for which the borrowers spent their newly acquired credit. This has led some writers on the subject to believe that all such loans went into the lengthening of the production period. Some did, of course, but Mises recognized that the lower interest rates attracted all producers who could use borrowed funds. Consequently all the resulting malinvestment does not result in longer processes. The effects depend on just who the borrowers are and how they spend their new credit in the market.”
“Since 1928, banks have extended credit expansion not only to business but also to consumers, and not only for short term loans but also for long term loans, so that the specific effects of credit expansion today are somewhat different than they were in the 1920s. However, the results are still, as Mises pointed out, a step-by-step misdirection in the use and production of available goods and services. As Mises wrote in 1928, as well as in ”Human Action”, the result is not overinvestment, as some have thought, but malinvestment. Investment is always limited by what is available.”
This context is important Lord Keynes considering (I believe) the heart of your critique is a footnote from Rothbard: “To the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur.”
Clearly, the quote you cite is not representative of the ABCT Mises defines in these two articles.
At the risk of piling on here, Mises expressly says in his 1928 paper: “Hardly anyone who wishes to be taken seriously dares to set forth the doctrine of the elasticity of the circulation of fiduciary media – its principal thesis and cornerstone.” In the US, this form of fiduciary media was (and is) called the “Real Bills Doctrine” (RBD). And this is important because, as Meltzer has recently demonstrated in his 2,000 page magnum opus “History of the Federal Reserve,” the entire US monetary system from 1913-1934 was based on & governed by RBD monetary theory. Most important, Meltzer proves it was this RBD mindset, (AKA the "Riefler-Burgess framework”) that focused the Federal Reserve on exactly the wrong signals for determining "loose" and "tight" monetary policy. And it was precisely this policy error --- concentrating on bank reserves above the legal minimum necessary to cover deposits for setting NOMINAL interest rates; instead of concentrating on the quantity of money, available credit and general economic conditions on inflation-adjusted REAL interest rates --- that resulted in its post Oct 1929 policy failure and consequently the impoverishment of millions of Americans.
ReplyDeleteIncidentally, Mises also makes clear in both his 1923 & 1928 papers that Govts must follow the rules of the gold exchange standard in order for it to function properly. Mises says in his 1923 paper trying to stabilize the monetary unit at a value over (as Britain did) or under (as France did) the value of gold is a fool’s game. And as Meltzer makes clear (as H Clark Johnson did before him), it was precisely the “sterilization” of gold inflows by the US Federal Reserve (and the Bank of France) using the RBD that caused the Great Depression. FYI – your namesake, Keynes, also spoke out against US & French gold sterilization at the time.
Fast forward to our current crisis…
Mian & Sufi estimate at least 39% of total new defaults between 2006 and 2008 were from 1997 homeowners -- EXISTING HOMEOWNERS -- who borrowed aggressively against the rising value of their homes using Home Equity Lines Of Credit (HELOC) w/ rates set at 3% above the Federal Reserve's short-term interest rate. About 2/3rds of US economic growth during the run up to the crisis was a result of existing homeowners borrowing 25 to 30 cents on every dollar of home value appreciation (itself fueled by demand resulting from the tidal wave of cheap credit via short-term adjustable & teaser interest rates made possible by the Federal Reserve). The point is these existing homeowners believed they could pay these loans based on the equity in their homes & based on the low interest rate. What's more, the evidence demonstrates these loans were NOT used to speculate; to "flip" homes or purchase second homes. This is an excellent real world example of en masse entrepreneurial error which results from interest rate manipulation by a central bank. Is it coincidence mortgage defaults began to rise and house prices began to fall in mid 2006 as the Federal Reserve was raising the Federal Funds rate? Are all the US & European empirical and counterfactual analyses documenting this causal relationship wrong? My point: this fits the Mises version of ABCT precisely.
Now, I completely agree Austrians were not the only ones to correctly forecast this bubble nor are they the only ones pointing to the Federal Reserve. Stanford Professor John Taylor’s “Getting Off Track” is the best example. Hell, it’s even been documented that Krugman knew – and expressly asked for --- the Federal Reserve to blow a bubble in US real estate via short term interest rate manipulation. To me, this whole part of your post --- who predicted the bubble --- is a waste of time because no one I know argues only Austrians got it right.
BTW – I don’t believe Hayek had to rewrite his theory based on Kaldor (or Sraffa for that matter) as you say. Kaldor’s attack on Hayek's "Ricardo Effect" -- using a comparative static equilibrium methodology – does NOT somehow refute the dynamic path of intertemporal discoordination & adjustment caused by credit expansion BEFORE a final equilibrium is reached. As Moss & Vaughn (1986) point out, "The problem is not to learn about adjustments by comparing states of equilibrium but rather to ask if the conditions remaining at T1 make the transition to T2 at all possible. Kaldor's approach indeed assumed away the very problem that Hayek's theory was designed to analyze, the problem of the transition an economy undergoes in moving from one coordinated capital structure to another."
ReplyDeleteIt's worth belaboring this point. As Steele (1992) explains, Hayek's earlier works (1929/1933 and 1931/1935) re: the impact upon investment incentives of a fall in the rate of interest (brought about by new money or new savings) ARE mutually compatible w/ Hayek's later two books (1939 and 1941) re: the impact upon investment incentives of changes in relative prices. Kaldor was wrong to represent the `interest rate effect' and the `relative prices effect' as inconsistent theoretical formulations. Steele further explains, "It is NOT the relative price rise of intermediate goods in the earlier stages of production which enhances their yields. Rather, the relative enhancement of their time-discounted yields (the result of new saving and the reduced rate of interest) attracts investment and causes their prices to rise. (This is the process which eventually restores equilibrium, but only in the absence of forced saving). It is hardly surprising that defenders of the Keynesian faith were able to play upon alleged contradictions between the 'two versions' of Hayek's theory."
To be clear, the debates between Kaldor, Sraffa, Hayek, Knight & others during the interwar period were concerned w/ whether or not a general theory of the business cycle could explain & predict the economic phenomena experienced at that time. The interwar economic crisis provoked a crisis in economic thinking at that time, just as our current economic crisis calls into question the validity of economic thinking today (i.e., the effectiveness of Keynes inspired Govt borrowing to boost aggregate demand). And it is w/in this context that the participants argued over whether or not a PORTION of Bohm-Bawerk's theory was suitable for use in such a theory. Specifically, Hayek demonstrated in "Prices and Production" that Bohm-Bawerk's average period of production can only be used w/ modification (i.e., by focusing on a period of investment NOT production, etc.). Moverover, these debates highlighted how macroeconomic equilbrium theories are poorly suited to describing the real world change dynamics of relative price adjustment w/in monetary economies based on roundabout production; these equilbrium theories do not pay enough attention to entrepreneurial decision making on a microeconomic level and the process in which entrepreneurs, interacting w/ each other, change their production processes such that the macroeconomic result is a change from one technique to another. Again, Bohm-Bawerk's capital-intensive direction is correct but only w/ modification can some of his explanations be used to correctly inform business cycle theory.
The Sraffa Hayek debate is best known for its lack of clarity. As Knight said to Morgenstern: "I wish he [Hayek] would try to tell me in a plain grammatical sentence what the controversy between Sraffa and Hayek is about. I haven't been able to find anyone on this side who has the least idea." Sraffa and Hayek did not agree on how best to model a monetary economy and, unlike Kaldor, Sraffa had not read Hayek's "Monetary Theory and the Trade Cycle" before Sraffa attacked Hayek's "Prices and Production." Clearly, Sraffa & Hayek defined equilibrium very differently w/ respect to natural interest rates. The fact that Keynes abandoned in his 1936 "General Theory" the use of the natural interest rate concept that Keynes used in his 1931 "Treatise on Money" -- based on Sraffa's criticism of Hayek -- did nothing to make Keynes's "General Theory" correct.
ReplyDeleteSeveral decades later, Hayek said "this capital-theory work shows more a barrier to how far we can get in efficient explanation than sets forth precise explanations. All these things I've stressed -- the complexity of the phenomena in general, the unknown character of the data, and so on -- really much more points out limits to our possible knowledge than our contributions that make specific predictions possible."
The best contemporary exposition (IMHO Lord Keynes) of what Hayek was attempting to say during the interwar period is explained in Huerta de Soto's "Money, Bank Credit, and Economic Cycles" (2nd English Ed 2009).
Now, regarding Minsky (whom I like a lot)…
ReplyDeleteMinsky’s FIH work is actually a regurgitation (of sorts) of Schumpeter (his teacher at Harvard), albeit clothed in the Keynesian vernacular of "animal spirits" and "effective demand."
As I understand it, the Austrian School would say Minsky's "fundamental flaw" is the legal privilege - granted by Govt to banks - to maintain fractional capital reserves. During the crisis the five largest investment banks successfully lobbied the SEC to reduce their fractional capital reserve requirements to "massively" increase bank leverage from 12.5 to more than 25 times equity. Surprisingly, the authors did NOT note that, at the height of the 2008 meltdown, the median large bank had borrowings of 37 times equity; these banks could be wiped out by a loss of just 2-3% of assets. Roubini & Mihm provide (in their book Crisis Economics) a pithy & chilling description of fractional capital reserve banking on pgs 82-85 which they call "The Lure of Leverage."
Schumpeter's notion that entrepreneurs need banks to provide new credit created out of thin air through fractional capital reserve lending to fund new projects -- because all existing investment capital is allocated to existing projects -- was immediately refuted by Schumpeter's teacher, Bohm Bawerk, when the "Theory of Economic Development" was first published in 1911. And while Minsky's financial instability hypothesis is correct to state that "over confidence beguiles its victims into debt" it also, however, fails to explain the source of the boom because it does not incorporate money's influence on relative prices for consumer goods and especially higher order goods w/in the intertemporal capital structure as this monetary liquidity is inflating the bubble prior to the bust phase of the crisis.
The real problem w/ Minsky's view is that it is the fractional capital reserve practice itself, w/in modern commercial banking, that makes banks what Minsky calls the "prototypical speculative financial organization." And Minsky completely blanks out the fact that fractional reserve banking is NOT inherent to capitalism; communist China's financial stability is also at risk precisely because its banks maintain only fractional capital reserves, too. In fact, just about every country today has granted banks this legal privilege.
So-called Austrians are not alone in concluding fractional capital reserve lending (along w/ central bank short-term interest rate manipulation) is the fundamental flaw Minsky should be referring to. Economics Nobel laureate Maurice Allais, (definitely NOT an Austrian), wrote: "The credit mechanism as it currently operates, based on the fractional coverage of deposits, the ex nihilo creation of money, and the long-term lending of short-term loan funds, substantially aggravates the disruptions mentioned. Indeed, all major crises in the nineteenth and twentieth centuries stemmed from an excessive expansion of credit, from promissory notes and their monetization, and from the speculation this expansion fueled and made possible."
ReplyDeleteRespectfully Lord Keynes, I encourage you to read up on the Mises version of ABCT and then provide a critique.
And for what little it’s worth, I stopped reading Rothbard after reviewing his horrible attack on Adam Smith… Like Menger (founder of the Austrian School) I’m a Smith fan even though his RBD fractional reserve central bank ideas are bunk.
Some comments:
ReplyDeleteThe point is these existing homeowners believed they could pay these loans based on the equity in their homes & based on the low interest rate. What's more, the evidence demonstrates these loans were NOT used to speculate; to "flip" homes or purchase second homes. This is an excellent real world example of en masse entrepreneurial error which results from interest rate manipulation by a central bank
And you appear to concede that ABCT in the form postulating investment in higher order capital goods does not explain this.
Now, I completely agree Austrians were not the only ones to correctly forecast this bubble nor are they the only ones pointing to the Federal Reserve
Low interest rates were not the fundamental cause of the bubble - it was the highly dysfunctional system of financial regulation that allowed reckless lending and bubbles to exist in the first place:
http://socialdemocracy21stcentury.blogspot.com/2009/11/financial-deregulation-and-origin-of.html
In the Bretton Woods era and even down to the 1980s before the onslaught of neoliberal regulatory systems, we had plenty of periods of low interest rates. Yet we did not experience massive asset bubbles and financial crises in those years.
Minsky’s FIH work is actually a regurgitation (of sorts) of Schumpeter (his teacher at Harvard)...
ReplyDeleteIn fact, Minsky's thesis takes up Irving Fisher's debt deflation theory of the Great Depression - this is a fundamental fact about Minsky's FIH.
So-called Austrians are not alone in concluding fractional capital reserve lending ... etc
Austrians do not even agree amongst themselves over FRB. In fact, there are pro-FRB Austrians:
Sechrest, Larry. 1993. Free Banking: Theory, History, and a Laissez-Faire Model, Westport, Connecticut: Quorum Books, 1993.
Selgin, George. 1998. The Theory of Free Banking: Money Supply under Competitive Note Issue. Totowa, New Jersey: Rowman & Littlefield.
Selgin, George A., and White, Lawrence H., 1996, “In Defense of Fiduciary Media – or, We are Not Devo(lutionists), We are Misesians!,” Review of Austrian Economics, Vol. 9, No. 2, pp. 83–107.
White, Lawrence H. 1995. Free Banking in Britain: Theory, Experience, and Debate, 1800–1845, 2nd ed. London: Institute of Economic Affairs.
I reject the arguments against FRB here:
http://socialdemocracy21stcentury.blogspot.com/2010/06/fractional-reserve-banking-evil.html
And just to be clear:
ReplyDeleteDo you agree or disagree that the Hayek/Garrison version of ABCT that postulates malinvestments in higher-order capital goods does NOT explain the 2000s bubble and financial crisis?
I both agree & disagree. Here’s why…
ReplyDeleteTake Hayek for example. In Prices & Production (PP) he essentially parrots the Mises version of ABCT from 1912. So, literally speaking, Hayek’s talking exclusively about malinvestment in higher order products (far removed in time from consumption) in the RBD credit environment. Hayek’s expressly NOT referring to homeowners borrowing against illusionary equity in their homes using low interest rates courtesy of the Federal Reserve (which is the Mian & Sufi example I provided to you).
On the other hand, three points:
1. I give the PP-era Hayek the same Percy Greaves Jr. 1977 quote “pass” that I give to the 1923 & 1928-era Mises. In case you missed it:
“The effects depend on just who the borrowers are and how they spend their new credit in the market.”
“Since 1928, banks have extended credit expansion not only to business but also to consumers, and not only for short term loans but also for long term loans, so that the specific effects of credit expansion today are somewhat different than they were in the 1920s. However, the results are still, as Mises pointed out, a step-by-step misdirection in the use and production of available goods and services. As Mises wrote in 1928, as well as in ”Human Action”, the result is not overinvestment, as some have thought, but malinvestment. Investment is always limited by what is available.”
I believe it’s disingenuous to argue because HELOC loans were not expressly called out by Hayek as a type of lower order product in-scope for his version of ABCT in PP (because they didn’t exist in the RBD credit environment at that time) Hayek’s version of ABCT therefore doesn’t accurately describe today’s crisis.
2. The Mian & Sufi analysis says HELOC’s accounted for at least 39% of the total defaults – it does NOT account for 100%.
3. Housing construction IS higher order (as described by Hayek in PP) and a lot of new construction occurred during this crisis because of the demand for housing stock which was driven by the tidal wave supply of cheap credit via teaser adjustable rates which were tied directly to the Federal Reserve’s short-term Federal Funds interest rate manipulation. This new housing stock – a lot of it now sitting empty – could only have been produced because of the Federal Reserve. Conversely, no too loose too long credit, no housing bubble. THIS is the point of John Taylor’s work in “Getting Off Track” and Taylor is not an Austrian.
Consequently, I don’t view the higher vs. lower order goods distinction as a litmus test for the legitimacy of any particular version of ABCT.
"Low interest rates were not the fundamental cause of the bubble - it was the highly dysfunctional system of financial regulation that allowed reckless lending and bubbles to exist in the first place"
ReplyDeleteI believe low interest rates were the fountainhead cause of the bubble – a systemic-wide bubble could not have formed w/o it. Yes, the SEC’s reduction in fractional reserve requirements fueled the spike in leverage was a contributing causal factor and yes, Fannie & Freddie’s perverse George Bush “ownership society” nonsense was a contributing causal factor, blah blah blah. Stepping back, more broadly, if your point is Govt policy blunders created this mess, I completely agree.
I believe low interest rates were the fountainhead cause of the bubble
ReplyDeleteI have already pointed out that low interest rates existed frequently in the 1945-1980 era, but no huge asset bubbles caused a collapse in the world financial system then. This was because there existed a superior system of financial regulation.
Stepping back, more broadly, if your point is Govt policy blunders created this mess, I completely agree.
Neoliberal government policy blunders contributed to the mess. But those blunders were inspired by New Classical economics, monetarism, and the (essentially neoliberal) new consensus macroeconomics.
An alternative macroeconomics like Post Keynesianism would NOT have made those mistakes.
"Austrians do not even agree amongst themselves over FRB. In fact, there are pro-FRB Austrians"
ReplyDeleteYes, I completely agree. There is more diversity of thought here than the mainstream is aware of. Mainstream glossing over big differences is nothing new. Most don't know Menger's formulation of subjective value is VERY different than that of Walras, Jevons & Gossen & it is his formulation that is impervious to Sraffa's attack.
George Selgin's "Less Than Zero" significantly impacted my thinking several years ago when I first read it. You forgot Hayek (in 1931, anyway) supported FRB & even went so far as to say private banks are not "guilty" of creating financial instability because Govt allows FRB!
I have no idea what "Post Keynesianism" means. Point me to it.
ReplyDeleteI have no idea what "Post Keynesianism" means. Point me to it.
ReplyDeleteI advocate it on this blog. Post Keynesianism is a heterodox macroeconomic school that never accepted the flawed axioms of neoclassical economics that were reintroduced into the neoclassical Keynesian synthesis by Hicks, Paul Samuelson and Robert M. Solow.
http://socialdemocracy21stcentury.blogspot.com/2010/07/three-varieties-of-keynesianism.html
http://en.wikipedia.org/wiki/Post-Keynesian_economics
Post Keynesianism has some affinities (but also major differences) with the radical subjectivist Austrian economics of Ludwig Lachmann (and Austrians influenced by him like O’Driscoll and Rizzo).
For example, see Ludwig Lachmann, “John Maynard Keynes: A View from an Austrian Window,” South African Journal of Economics 51 (1983): 253–260. A sample:
“In the field of methodology Keynes and the Austrians agree that economics is a social science to which methods that have proved successful in the natural sciences should not be applied without careful inspection, and that, in particular, all attempts to ‘give numerical values’ to the parameters of economic models ignore the essential meaning of economic theory. It is hardly surprising that even here we find differences of accent and perspective, but … they do not amount to much …. Keynes concurs with Hayek's misgivings about numerical values. …. But Keynes’s mind also moves in another direction. ‘I also want to emphasize strongly the point about economics being a moral science. I mentioned before that it deals with introspection and with values. I might have added that it deals with motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth’ … Keynes sees in social facts manifestations of the human mind. While to Hayek it is the complexity of these facts, their multitude and diversity, that defies the attribution of numerical values to social concepts, to Keynes it is their mental character … that does so. Rather to the surprise of some of us, Keynes emerges as being more deeply committed to subjectivism than is his Austrian opponent. Lachmann 1983: p. 256.
You might note Gerald P. O’Driscoll and Mario J. Rizzo made some favourable comments about Post Keynesian economics in their book The Economics of Time and Ignorance (Oxford, UK, 1985, p. 9):
ReplyDelete“[i]t is evident that there is much more common ground between post-Keynesian subjectivism and Austrian subjectivism …. the possibilities for mutually advantageous interchange seem significant.”
Though the leading American Post Keynesian Paul Davidson disagrees (Davidson, “The Economics of Ignorance or Ignorance of Economics?,” Critical Review (1989) 3.3/4: 467–487; and “Austrians and Post Keynesians on Economic Reality: Rejoinder to Critics,” Critical Review 7.2/3 (1993): 423–444).
Some prominent Post Keynesians (living and dead):
Sidney Weintraub (1914–1983), Nicholas Kaldor, Paul Davidson, Geoffrey C. Harcourt, Victoria Chick, Jan A. Kregel, Basil J. Moore, Sheila Dow, Thomas I. Palley, Malcolm Sawyer, Philip Arestis, Marc Lavoie, Steve Keen and Mark Hayes.
Hyman Minsky’s work is also highly regarded in Post Keynesian economics.
I might also add that the Austrian school seems to me to be to be split into these groups:
ReplyDelete(1) the Anarcho-capitalists, like Rothbard and Hoppe.
(2) The minimal state Austrians like Mises (with his praxeology).
(3) The "orthodox" Austrians who have a moderate subjectivist position (like Israel Kirzner and Roger Garrison). Garrison even does "Austrian macroeconomics", which seems peculiar to me given that other Austrians reject the whole concept of macroeconomics.
(4) Radical subjectivists like Ludwig Lachmann, and Austrians influenced by him like O’Driscoll and Rizzo.
What position do you take?
And course there are non-Austrian libertarians too:
ReplyDelete(1) Randians;
(2) Robert Nozick's libertarianism;
(3) David D. Friedman's anarcho-capitalism.
P.S.
ReplyDeleteAnd also the non-Austrian Cato Institute libertarians (e.g., Tom Palmer) and other ones like Bryan Caplan and Tyler Cowen.
"I have already pointed out that low interest rates existed frequently in the 1945-1980 era, but no huge asset bubbles caused a collapse in the world financial system then. This was because there existed a superior system of financial regulation."
ReplyDeleteTell me please Lord Keynes when precisely low REAL interest rates – not NOMINAL rates -- existed (below what they’d have been w/o central planning by the Federal Reserve) between 1945-80. Moreover, please share w/ me the specific “superior financial regulations” during this period which prevented “huge asset bubbles.”
My point is: Yes, you've made this sweeping statement but it doesn’t disprove low REAL interest rates created by the central bank are the root cause of asset bubbles. You've simply cherry-picked a period w/in the 1913-2010 time series in which the inherently unstable FRB central bank operating model didn't create a depression.
The Federal Reserve was created in 1913 so we must begin there. Now, I see from this blog you agree the Federal Reserve is culpable for the 1920-21 recession. The Federal Reserve caused the Great Depression (whether you agree or not) and the Federal Reserve caused the 1936-37 recession (whether you agree or not) as even C Romer admits. From that point until 1951 the Federal Reserve was essentially managed by the US Treasury to monetize the war debt through inflation – the devaluation of our purchasing power.
Incidentally, Keynes inspired economists were completely wrong immediately following WWII. Hansen, Currie, etc all claimed depression would follow WWII because Govt war "stimulus" would be removed. In fact, the opposite – growth – happened after this war.
The Federal Reserve, w/ its new found "independence" in 1951, continued to create lots of recessions up to 1965. True: the Federal Reserve didn’t create a depression but this does not disprove low REAL interest rates are the cause of systemic asset bubbles.
1965-1980 was the “Great Inflation” - the Federal Reserve’s perverse policy of wealth destruction by devaluing the money in our pockets. This period too does NOT disprove the bubble creating ability of REAL interest rates below what they’d otherwise be if not for central bank manipulation. In fact, the Federal Reserve's best performance for the longest period is the "Great Moderation" during most of Greenspan's reign however, he's the same statist who gave us the dot com bubble and who (along w/ Bernanke) brought us our current mess.
I respectfully recommend you check out Meltzer’s History of the Federal Reserve & reconsider your statement.
"What position do you take?"
ReplyDeleteI don't subscribe to any particular group, per se because I don't bother to study the edges of their differences - my day job's too intense for that. Understanding alternative positions is only a by product of my study of economic events & theory. I care about truth (conformance w/ reality) not the positions of others. Besides, group affiliation smacks of group think in my mind, I prefer to remain independent to speak freely. I refuse to pretend any one thinker (be they Mises, Smith, Hayek, Keynes, etc.) is 100% correct on all issues. I don't like the taste of dogma food.
Tell me please Lord Keynes when precisely low REAL interest rates – not NOMINAL rates -- existed
ReplyDeleteThen find a graph of real interest rates from 1945-2010. It shouldn’t be that difficult.
This chart appears to show nominal interest rates:
http://www.ritholtz.com/blog/2009/05/us-interest-rates-since-1950s/
I would be surprised if real rates weren’t as low 1945-1965 as in the 2000s bubble.
Moreover, please share w/ me the specific “superior financial regulations” during this period which prevented “huge asset bubbles.”
See here:
http://socialdemocracy21stcentury.blogspot.com/2009/11/financial-deregulation-and-origin-of.html
You've simply cherry-picked a period w/in the 1913-2010 time series in which the inherently unstable FRB central bank operating model didn't create a depression.
And the fact that NO depression happened should cause you to ask why.
Incidentally, Keynes inspired economists were completely wrong immediately following WWII. Hansen, Currie, etc all claimed depression would follow WWII because Govt war "stimulus" would be removed
You drag up that tired old argument. Guess what? Keynes did not think so:
“Keynes harshly REJECTED the risk of post-war stagnation, holding that because of Social security there would be a large reduction in private saving and so that would be no problem.”
The Coming of Keynesianism to America, p. 202
Just because Samuelson and others thought the economy would slide back into recession shows nothing more than that they were wrong. They should have listened to Keynes.
1965-1980 was the “Great Inflation” - the Federal Reserve’s perverse policy of wealth destruction by devaluing the money in our pockets.
You badly mangle history. Double digit inflation was caused by the oil shocks – this wasn’t the Federal Reserve, and even the higher single digit inflation was due to a number of factors (e.g., dismantling of the US commodity buffer stocks and a surge in primary commodity prices from 1969 onwards), all exacerbated by the breakup of Bretton Woods and wage-price spirals:
Nicholas Kaldor, (1976) “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–14.
Some other points:
ReplyDeleteThe Federal Reserve caused the Great Depression
It did not. Its contractionary policy exacerbated the downturn.
and the Federal Reserve caused the 1936-37 recession
Roosevelt’s budget balancing had a major role in that, not just Fed policy.
From that point until 1951 the Federal Reserve was essentially managed by the US Treasury to monetize the war debt through inflation – the devaluation of our purchasing power.
No, it wasn’t.
It was run to achieve full employment and low inflation – targets it both achieved.
That inflation eroded the purchasing power of the dollar totally ignores the fact that people’s real wages shot up rapidly and that they experienced very great increases in living standards. This was a period of unparalleled economic growth and rising wealth - by Keynesian monetary and fiscal policies and financial regulation.
And, incidentally, the Post-WWII boom (1945-1949) due to pent up consumer demand is explained PRECISELY in Keynesian terms.
ReplyDeletePeople accumulated income in the war years and couldn't spend it because of rationing and the wartime production economy taking resources away from production of consumer goods. Demand surged and was let loose in 1945 - this is classic demand-side Keynesian economics.
Your link to a chart of the nominal fed funds rate vs 10 yr treasuries & corp bonds between 1950-2009 does not answer my question re: when precisely low REAL interest rates – not NOMINAL rates -- existed below what they’d have been w/o central planning by the Federal Reserve between 1945-80.
ReplyDeleteMoreover, how precisely does your chart disprove the argument: REAL interest rates (not NOMINAL rates) below what they’d otherwise be w/o central planning by the Federal Reserve create asset bubbles?
“Just because Samuelson and others thought the economy would slide back into recession shows nothing more than that they were wrong.”
ReplyDeleteThank you for agreeing w/ me that these Keynes inspired economists were wrong to say removal of Govt’s war ‘stimulus’ would result in recession.
You also say these Keynes inspired American economists “should have listened to Keynes.”
Now, if Keynes himself was the only Keynesian capable of using his framework & methodology to get it right, how can you be certain that “An alternative macroeconomics like Post Keynesianism would NOT have made those mistakes [the Govt policy blunders responsible for our current economic mess]?
Is Christina Romer a “Post Keynesian”?
If the post WWII boom was so easily explained in Keynesian terms and classic demand-side Keynesian economics how is that leading American Keynes inspired economists got it so PRECISELY wrong?
ReplyDeleteI'd appreciate your point of view... I mean, don'tcha wonder how they got it so wrong?
In response to my request to please share w/ me the specific “superior financial regulations between 1945-1980 which you say is prevented “hugh asset bubbles” to provide a link to a long post that talks about many things other than my request. I assume you’re pointing me to this portion of the post in the link:
ReplyDelete“For instance, from about the 1930s to the 1980s, many countries had policies of financial regulation that included many of the following:
1. Interest rate ceilings
2. Liquidity ratio requirements
3. Higher bank reserve requirements
4. Capital Controls (that is, restrictions on capital account transactions)
5. Restrictions on market entry into the financial sector
6. Credit ceilings or restrictions on the directions of credit allocation
7. Separation of commercial from investment (“speculative”) banks
8. Government ownership or domination of the banks.
(Ito 2009: 431–433).
These were abolished as financial liberalization and capital account liberalization became widely adopted in the 1980s and 1990s.
In the case of the US, we can point to a number of important acts of financial deregulation that were the direct causes of the crisis:
(1) Repeal of the Glass-Steagall Act (1999)
In the US, the Glass-Steagall Act, initially created in the wake of the Stock Market Crash of 1929, prohibited banks from both accepting deposits and underwriting securities. This led to segregation of investment banks from commercial banks. Glass-Steagall was effectively repealed for many large financial institutions by the Gramm-Leach-Bliley Act in 1999.
Joseph Stigliz has argued that
“The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns” (Stiglitz 2009).
Deposit insurance does make sense when it protects a commercial banking sector prevented from making highly speculative and risky investments.
(2) Hiding Liabilities on Off-Balance Sheet Accounting
Banks used off-balance sheet operations called special purpose entities (SPEs) or special purpose vehicles (SPVs) to take on toxic asset-backed securities…”
Is this your answer to my request?
suo Marte: “From that point until 1951 the Federal Reserve was essentially managed by the US Treasury to monetize the war debt through inflation – the devaluation of our purchasing power.”
ReplyDeleteLord Keynes: “No, it wasn’t.
It was run to achieve full employment and low inflation – targets it both achieved.”
From Chapter 7 (“Under Treasury Control, 1942 to 1951"), Vol 1, pgs 579-8 of Meltzer’s History of the Federal Reserve:
“The period from 1942 to March 1951 divides almost equally into years of war and years of peacetime expansion. For Federal Reserve policy, the period can be treated as a whole, a repeat with different details and a different outcome of the experience during and after WW I. Once again the Federal Reserve put itself at the service of the wartime Treasury, and once again it had difficulty extricating itself from Treasury’s grasp after the war. And again it took almost as much time to free postwar monetary policy as to fight the war."
"The Federal Reserve summarized its “primary duty” in wartime as “the financing of military requirements and of production for war purposes” (Board of Governors of the Federal Reserve System 1947)."
“After the war, Congress removed controls (1947), but it soon restored them (1948). In the early postwar years, the Federal Reserve used margin requirements to limit securities purchases. Credit controls proved difficult to administer and ineffective against inflation.”
“Eccles described his work in wartime as “a routine administrative job…The Federal Reserve merely executed Treasury decisions” (Eccles 1951, 382). When his term ended in February 1944, he offered to resign but agreed to remain if the president would commit to consolidation of banking regulation and supervision under a single agency. His appointment as a member of the Board ran to 1958, as chairman to 1948.”
Incidentally, Meltzer in the footnote on pg 580 also writes:
“According to Eccles, Roosevelt agreed to consolidate the banking agencies but soon afterward rejected Eccles’s proposal. Eccles did not resign.”
I believe Lord Keynes I’ve quoted enough from Meltzer’s history above to prove I’ve accurately characterized the Federal Reserve. Are you mature enough to acknowledge this fact?
Or, are you saying me, Meltzer, the Board of Governors of the Federal Reserve System and the Chairman of the Federal Reserve (Eccles) are all wrong & you're correct?
suo Marte: "1965-1980 was the “Great Inflation” - the Federal Reserve’s perverse policy of wealth destruction by devaluing the money in our pockets."
ReplyDeleteLord Keynes: "You badly mangle history. Double digit inflation was caused by the oil shocks – this wasn’t the Federal Reserve, and even the higher single digit inflation was due to a number of factors (e.g., dismantling of the US commodity buffer stocks and a surge in primary commodity prices from 1969 onwards), all exacerbated by the breakup of Bretton Woods and wage-price spirals:
Nicholas Kaldor, (1976) “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–14."
Respectfully Lord Keynes, do you really want to put my source Meltzer's History of the Federal Reserve against a journal article by Kaldor to dispute the Federal Reserve's "Great Inflation"? Please give this some thought and let me know.
suo Marte: "The Federal Reserve caused the Great Depression"
ReplyDeleteLord Keynes: "It did not. Its contractionary policy exacerbated the downturn."
I respectfully recommend you update your reading my friend. You're simply wrong. Tell me precisely where Meltzer is incorrect in his History of the Federal Reserve Vol 1.
Your denial of reality is stunning. Even Chairman Bernanke admitted the Federal Reserve is responsible in his March 2009 interview on 60 Minutes... I'm sure it's posted on YouTube somewhere if you don't believe me.
I don't mean to give you a hard time here Lord Keynes but denial of reality makes constructive dialogue very difficult. Have you actually read Meltzer's Vol 1 (or Vol 2 for that matter)?
Lord Keynes, back to my original questions in my original post which you've not answered:
ReplyDelete1. Considering you know Mises is the fountainhead of the “Austrian” version (which is a “mere elaboration” in his own words) of the old Monetary Theory of the Trade Cycle, why critique Rothbard instead of Mises?
2. Have you read Mises's 1923 & 1928 papers ("stabilization of the monetary unit from the viewpoint of theory" and "monetary stabilization and cyclical policy," respectively) - Yes or No?
Also, a new question: Have you actually read Mises's "Theory of Money & Credit" in which the ABCT "elaboration” of the old Monetary Theory of the Trade Cycle was first put forward - Yes or No?
And to be crystal clear, Lord Keynes: do you contend the Mises version of the Monetary Theory of the Trade Cycle does not accurately describe the current financial crisis - Yes or No?
ReplyDeleteRegarding the chart, I never said it showed real interest rates.
ReplyDeleteI suggested that you might like to find a chart with real interest rates to prove your own points.
But given that real interest rates are nominal rates minus inflation, you could easily do some calculations based on the nominal rate.
In 1956/1957/1958, the Federal funds rate went down to about 1%.
US inflation in those years:
1956 1.5
1957 3.3
1958 2.8
The real interest rate must have been negative in 1957/1958/1959
Perhaps even -2.3% around 1958.
From 2002-2004, the Federal funds rate was about 2% and 1%
US inflation rates
2002 1.6
2003 2.3
2004 2.7
2005 3.4
In 2002 it probably went negative, and in 2004 it was probably about -1.7%.
In other words, exactly what I said: about the same level as in 1956-1959, and perhaps 1958 had even lower negative rate.
It also looks like 1961/1962 had almost zero real interest rates as well.
Is Christina Romer a “Post Keynesian”?
ReplyDeleteNo. She is a neoclassical New Keynesian
Keynesian terms and classic demand-side Keynesian economics how is that leading American Keynes inspired economists got it so PRECISELY wrong?
There weren’t “PRECISELY wrong” at all.
First, in actual fact there WERE 2 recessions after WWII:
Recession of 1945, Feb–Oct 1945, GDP decline: −12.7%
"The decline in government spending at the end of World War II led to an enormous drop in gross domestic product making this technically a recession. This was the result of demobilization and the shift from a wartime to peacetime economy. The post-war years were unusual in a number of ways (unemployment was never high) and this era may be considered a "sui generis end-of-the-war recession"
Recession of 1949, Nov 1948–Oct 1949, GDP decline: −1.7%
US fiscal policy in 1948-1949 shifted to a class Keynesian stimulus that ended this recession.
http://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States
So tell me again, how are these facts not explained by Keynesianism?
Norman Frum, Recession Prevention Handbook: Eleven Case Studies, 1948-2007, p. 55
And regarding my earlier comment: Samuelson thought there would a slide back into actual depression and stagnation after the war:
Burton Feldman, The Nobel Prize: A History of Genius, Controversy, and Prestige, p. 340.
He was wrong. Keynes was right.
The global prosperity and full unemployment post-1945 under Keynesianism economics also shows Keynes’ system was right. Pointing to some mistaken predictions in the first years of the Keynesian era by early Keynesians, as though this is some powerful argument against Keynesian theory is ridiculous.
Respectfully Lord Keynes, do you really want to put my source Meltzer's History of the Federal Reserve against a journal article by Kaldor to dispute the Federal Reserve's "Great Inflation"?
ReplyDeleteIf you want to refute Kaldor, go ahead and offer actual arguments refuting him, don’t resort to a lazy appeal to authority fallacy.
Tell me precisely where Meltzer is incorrect in his History of the Federal Reserve Vol 1.
Why on earth would Meltzer be the only source you consult on the causes of the Great Depression?
Perhaps you are unaware of, say, Irving fisher’s debt deflation theory, as developed by Hyman Minsky?
Even Chairman Bernanke admitted the Federal Reserve is responsible in his March 2009 interview on 60 Minutes.
His is another lazy appeal to authority fallacy. Just because Bernanke said something it does make it true.
And incidentally, Bernanke holds the monetarist view of Friedman that Fed policy exacerbated the depression, not caused it. This is not incompatible with the view that its fundamental causes were
(1) a poorly regulated/essentially laissez faire financial system;
(2) irrational speculation on asset prices
(3) excessive private debt used to fuel asset speculation
(4) bursting of the asset bubble
(5) debt deflation
(6) a spill over into the real economy
(7) bank runs, bank collapses
(8) debt deflationary spiral
All of this was made worse by incompetent Fed policy (with its “gold standard” mentality and a gold exchange standard that transmitted deflationary shocks to other countries), but that was not the fundamental cause.
Another point: the US had serious depression in the 1890s when the Federal reserve did not even exist.
Australia also suffered a horrific depression at the same time, when it had no central bank, a free baking system and a gold standard.
The business cycle existed long before central banks.
Considering you know Mises is the fountainhead of the “Austrian” version (which is a “mere elaboration” in his own words) of the old Monetary Theory of the Trade Cycle, why critique Rothbard instead of Mises?
ReplyDeleteBecause Rothbard’s version appears to be more influential amongst modern Austrians.
Regarding Mises’ essays “Stabilization of the Monetary Unit from the Viewpoint of theory" and “Monetary stabilization and cyclical policy”, I have found them in The Causes of the Economic Crisis and Other Essays before and after the Great Depression (ed. P. L. Greaves), Ludwig von Mises Institute, Auburn, Ala., and will read them.
Have you actually read Mises's "Theory of Money & Credit" in which the ABCT "elaboration” of the old Monetary Theory of the Trade Cycle was first put forward
What are pages numbers exactly, for the 1953 edition? (trans. H.E. Batson; Yale University Press, New Haven).
I expressly didn’t engage in your type of interest rate comparison because it its simplicity is its error. Federal Reserve policy during the 1956-58 period relied on Regulation Q, multiple discount rates by the various Reserve System branches AND federal funds rate changes to control credit expansion. In other words, when market rates declined, the Federal Reserve interpreted the decline as “easy” monetary policy and when rates rose, the Federal Reserve believed the rise was “tight” monetary policy. As Mises would argue, this simplicity obscures how changes in the quantity of money alters current and expected future prices on assets and exchange rates. And this is why Federal Reserve performance was “mixed” during the 1950s leading up to The Great Inflation. The Federal Reserve's incoherent policies gyrated the economy from recession to expansion throughout your so-called "Golden Age" of Keynesianism. The Federal Reserve’s monetary policy (during this period) was PROCYCLICAL NOT COUNTERCYCLICAL; the Federal Reserve slowed money supply growth when rates FELL and permitted faster money supply growth when rates ROSE.
ReplyDeleteYou really need to understand what discounting is & its role in the expansion & contraction of credit which is the expansion & contraction of the quantity of money. This is not something that can be explained in a few sentences and I’m NOT engaging in “an appeal to authority” here. You need to understand how credit expansion & contraction worked during the 1950s and if you did, you would not have made the simple comparison of 1956-58 to 2002-05. Please refer to pgs 104-105 of Mises’s elaboration of Circulation Theory in his 1928 paper to explain the theoretical error behind the Federal Reserve’s discount rate actions during this period. You’re obviously unaware the discount rate INCREASED from 1.5% to 3.5% in a series of seven steps between 1954-57.
The US experienced a “sharp recession” between 6/1953 and 5/1954 according to the NBER. Real GNP fell 3.2%, industrial production fell 9.4% and unemployment increased above Govt’s “4% full employment target” to 6.1% As this was the first recession under a Republican president since 1929, the Federal Reserve began a round of easy monetary policy. As a result of this procyclical expansion of the money supply, the recovery from recession lasted 13 quarters between 1955-57; real GNP rose at an average 3.4% annual rate and industrial production at a 6% average rate and after a sharp decline in 1956 it returned to an annual growth rate of 2-4% until the start of the 1957-58 recession. Please see pages 106-172 of Book 1, Vol 2 of Meltzer’s History of the Federal Reserve for the sources of my empirical proof here. Also beginning on pg 172 is the empirical proof of the 1958-60 expansion.
Suffice to say, you’ve again simply cherry-picked apples & oranges rates and attempting to compare them. Reality is much more complicated than your analysis. Bottom line: your comparison absolutely does not refute the fact that the Federal Reserve creates asset bubbles when it artificially holds the real interest rate below what it otherwise would be w/o this manipulation.
I’m leaving for NYC today for work & not back until Friday. I will follow up w/ you then. And thank you for saying you’ll read the Mises papers from 1923 & 1928. I’d also encourage you to purchase the Meltzer books (both Vols 1 & 2). Amazing amounts of data here – astounding really. The story goes he had as many as 12 students doing the research, on & off, over a multi-year period. If you appreciate lots facts, details & primary sources as I do, you’ll love this book.
Best.
LK, you're confusing cause and effect, and using a field full of straw-men to give the illusion that you're actually attacking the real ABCT.
ReplyDeleteFirst, is there a single written account of the ABCT? No. Just as there is no single written account of a theory of gravity. Each physicist formulates his own application of general principles, and there can be substantial disagreement amongst them even when a single set of general principles are chosen. So ABCT, as a general set of principles, lays out that interventions into the interest market, and the market generally, by a non-profit motivated actor necessarily disrupts the capital structure of the entire market, diminishing the responsiveness of the capital structure to profits and losses.
Could this formulation be attacked as not being "the true Autrian"? Certainly. But according to this formulation it is easy to see that Fed monetary policy, FHA and HUD intervention, Fannie Mae and Freddy Mac, and tax incentives gave private profit-and-loss actors the means to give contracts and develop a service industry that WOULD HAVE BEEN UNSUSTAINABLE but for the govt interventions.
More to the point, as these lines of production are insulated from immediate market corrections through govt fiat, they expanded and subsumed more of the market share of end-consumers. But as the market sought equilibrium, those who were making profits from being the beneficiaries of govt policy suddenly realized that there was no longer any benefits in the structures they had established because there were losses that the govt couldn't make disappear.
This explains why there can be a boom/bust even in mortgages for "consumer's" homes - its not just the home, but the capital structure involved in creating and selling and repackaging and insuring the real estate MORTGAGES. The capital structure in these mortgages and their resale market is what was distorted by govt intervention. It makes no difference that the end product was a consumer's good. In fact, the goal of all capital structure is to produce consumer's goods so your contention is truly misguided in claiming that because consumers were affected, the ABCT must be faulty.
Lord Keynes, in your Nov 14th post you said you’d read the two Mises papers (“Stabilization of the Monetary Unit from the Viewpoint of Theory" from 1923 and “Monetary Stabilization and Cyclical Policy" from 1928) that I've pointed you to.
ReplyDeleteHave you read them?
And if so, do you now agree that the Mises version of the old Circulation Credit Theory of the Trade Cycle (now known as the Austrian Business Cycle Theory) accurately explains the current financial crisis – Yes or No?
Lord Keynes, this short text will actually prove (and also disprove) your assertion about the failure of the ABCT in explaining the Crisis of 2008:
ReplyDeletehttp://www.economicthought.net/2009/08/consumer-credit-and-the-theory-of-the-cycle/
There, Jesus Huerta de Soto claims that when credit expansion is targeted to consumer goods, it also triggers a boom/bust cycle. He actually says that Rothbard's claim was wrong all the way.
Suo,
ReplyDelete"Now, regarding Minsky (whom I like a lot)…
Minsky’s FIH work is actually a regurgitation (of sorts) of Schumpeter (his teacher at Harvard), albeit clothed in the Keynesian vernacular of "animal spirits" and "effective demand." "
The Financial Instability Hypothesis essentially flows from three propositions:
1. Any model of capitalism must be able to produce a depression or a collapse as a potential outcome (his own conjecture).
2. Money is created endogenously by banks as credit (Schumpeter)
3. The future is uncertain, and expectations are subjective (Keynes)
Schumpeter stated in his work that endogenous expansion of purchasing power by banks was required for entrepreneurs to create new markets. Minsky ran with this idea and asked what would happen if instead that endogenous expansion of purchasing power was funneled to gamblers and speculators who used the funds to play casino in asset trading on a rising market.
You've been unfair to ABCT here--expansion of the money supply via the Federal Reserve makes it easier for irresponsible lending in the private sector to occur, and housing is, in fact, a capital good (an Austrians think of them) because houses are expensive to build, involve a lot of 'higher-order' goods, and it takes a while for the payoff from building them to occur (again, it's highly likely less houses would've been built if the Fed hadn't lowered interest rates as low as they did in the early 2000s). (None of this is intended to be taken as an endorsement of ABCT).
ReplyDelete"expansion of the money supply via the Federal Reserve makes it easier for irresponsible lending in the private sector to occur"
DeleteLow interest rates ***with poorly regulated banks and financial institutions** make it easy for "irresponsible lending in the private sector to occur" -- that does not vindicate ABCT.
Also, economists dispute whether houses are capital goods.
And even if true none of those points vindicates the theory: ABCT already fails on the non-existence of the unique Wicksellian natural rate and the false loanable funds theory.
I am not attempting to vindicate ABCT. That's why I said my post shouldn't be taken as an endorsement of ABCT. I said you were being unfair to ABCT, as in your argument against it was invalid.
ReplyDeleteMy point was that according to ABCT, excessive debt and reckless lending are more likely to occur if the money supply expands much faster than overall production / interest rates are below the 'natural rate' (not that I believe in such a thing). My point was just that the excessive debt and reckless lending of the 2000s is consistent with ABCT. In other words, ABCT doesn't say that the only form of malinvestment to occur would be in the form of 'capital goods' (in Austrian sense), but also loans that can't be repaid, too much speculation, etc.
"In other words, ABCT doesn't say that the only form of malinvestment to occur would be in the form of 'capital goods' (in Austrian sense), but also loans that can't be repaid, too much speculation, etc."
DeleteOn the contrary, the classic ABCT is only
concerned with real capital investments -- there is nothing in it about consumer debt or asset bubbles.
That the Austrians have been forced to come up with ad hoc changes to their theory only suggests that it is like epicycles on epicycles.
Sure, as originally formulated; I wouldn't dispute that. But ABCT has evolved since then. Austrian economists don't talk about ABCT like it's just what Hayek wrote (note that you said 'classic ABCT'). It's perfectly sound to say that it's consistent the original ABCT theory that 'artifically low interest rates' could lead to a consumer debt or asset bubble *also* and not just a shift to 'capital goods', because it's fundamentally a theory about malinvestment/unsustainable activities. Nowadays, when people talk about ABCT, they're talking about it like Murphy and the other Mises Institute folks talk about it, where the emphasis is on any unsustainable economic activity linked to expansion of credit and/or the money supply in excess of overall production, not just what Hayek wrote.
ReplyDeleteAnd just because a theory undergoes changes doesn't make it wrong. I mean, you call yourself a post-Keynesian, presumably because you see flaws in Keynesian theory from 40 years ago. So it's reasonable to assume Keynesian theory you subscribe to will be different in 20 years because of any failures it has to explain economic phenomena in the 2020s. But would that mean Post-Keynesianism fails to explain the 2008 financial crisis? Concordantly, I don't see how Hayek's failure to understand the full implications of his theory invalidates modern-ABCT (regardless of its merits).
On the contrary the modern ABCT has all the flaws of Hayek's theory:
Deletehttp://socialdemocracy21stcentury.blogspot.com/2013/08/why-austrian-business-cycle-theory-is.html
That the modern Austrians have tried desperately to make their theory fit the evidence only underscores its failure.
Your argument seems to be that because ABCT fails to explain 2008, it's incorrect. That's assuming ABCT is a comprehensive theory of recessions. However, ABCT only is an explanation of why some recessions occur--recessions caused by a large increase in the money supply and/or a large increase in credit which leads to a shift to 'capital goods'. It doesn't explain, for example, why a recession would be caused by a war, or the invention of a new technology. That some Austrian economists have adapted/expanded ABCT to explain more of economic history is hardly an argument for why older versions of ABCT could never explain any recession accurately, or, at least, one factor among several (because a recession won't necessarily have only one cause).
ReplyDelete"Your argument seems to be that because ABCT fails to explain 2008, it's incorrect. "
DeleteThat is not my argument. Yes, ABCT does not explain the 2008-2009 crisis and recession, but this is not the reason why it is false.