For the current discussion of ABCT by bloggers, I direct readers to these links:
David Glasner, “Ludwig von Mises and the Great Depression,” Uneasy Money, February 10, 2012.However, Horwitz’s defence of the ABCT has a number of problems:
David Glasner points out that R. G. Hawtrey and Gustav Cassel were warning of an economic crisis from about 1928. I would also add that the American Harvard Economic Service (quoted by Hayek in November 1928 in his monthly reports for the Austrian Institute for Business Cycle Research) was also predicting that some market liquidation and problems would emerge on the US capital market in 1929. Glasner also rightly disputes the idea that the ABCT was “ignored” by economists in the 1930s. The ABCT was widely discussed and eventually rejected by economists.
Lars Christensen, “I am Blaming Murray Rothbard for my Writer’s Block,” The Market Monetarist, February 11, 2012.
This post rejects Rothbard’s view of the causes of the Great Depression. The author writes from a monetarist perspective.
Steven Horwitz, “What the Austrian Business Cycle Theory Can and Cannot Explain,” Coordination Problem, February 11, 2012.
Steve Horwitz here defends the ABCT, but acknowledges what he sees as its shortcomings and limitations.
(1) I find it curious that Horwitz appeals to the non-existent, unique Wicksellian natural rate of interest. There is no such thing, and other Austrians like J. G. Hülsmann and Robert P. Murphy also admit this. All versions of ABCT which use such a concept are fatally flawed. Hülsmann argues that Mises’s later versions of ABCT actually dispensed with the natural interest rate concept.
(2) Horwitz states:“Once the turning point is reached, ABCT tells us little to nothing about how the bust will play out. Yes, we know that further inflation and interventionist attempts to prevent the necessary reallocation of resources will make matters worse, but the theory by itself doesn’t tell us a priori how this will play out in any given historical circumstance. The ABCT is not a theory of the causes of the length and depth of recessions/depressions, but a theory of the unsustainable boom.Even if one were to accept the validity of the ABCT as Horwitz himself does, there is a serious problem in this argument.
To turn to Christensen’s particular example: the ABCT cannot explain the entirety of the Great Depression. It simply can’t. And adherents of theory who make the claim that it can are not doing the theory any favors. What ABCT can explain (at least potentially, if the data support it) is why there was a recession at all in 1929. It argues that it was the result of an unsustainable boom initiated by an excess supply of money at some point in the 1920s. Yes, the bigger the boom, cet. par., the worse the bust, but even that doesn’t tell us much. Once the turning point is reached, there’s not a lot that ABCT can say other than to let the healing process unfold unimpeded. In the context of the Great Depression, one has to invoke other theories to explain why the bust, whose onset the ABCT explains, became so deep and so long. And that is where Friedman and Schwartz’s work on the 1929–33 period along with awful policies of the Hoover administration, ably documented by Rothbard in AGD and updated in this Cato piece of mine from last year, are required to explain why things got so bad so quickly.”
Steven Horwitz, “What the Austrian Business Cycle Theory Can and Cannot Explain,” Coordination Problem, February 11, 2012.
Having asserted that the ABCT does not explain the depth or length of the Great Depression (for which other explanations are necessary, he says), Horwitz commits a non sequitur: he contends that nothing must be done by government to “prevent the necessary reallocation of resources,” and that the healing process must “unfold unimpeded.” These ideas do not follow. And, in appealing to the work of Friedman and Schwartz on the Great Depression, Horwitz can only be tacitly endorsing the view that it was lack of central bank stabilization of the money supply that has a major factor in exacerbating the downturn. This means government interventions are required in such circumstances.
Horwitz also ignores the fact that Hayek retreated from his liquidationism in the 1930s and later, and eventually supported qualified Keynesian stimulus in a depression. So did Ludwig Lachmann.
Just to pick up where we left off a while back in our discussion of the Sraffa-Hayek affair, while I believe that there actually is a Wicksellian natural rate -- it is defined up to a scalar multiple corresponding to the choice of a numeraire -- the natural rate has no policy relevance outside a state of full general equilibrium. Outside full general equilibrium, the natural rate is not well defined, and even if we knew what it was (i.e., the rate in full GE), it would not necessarily be the appropriate interest rate for an economy not in a state of full general equilibrium. So while our positions are not exactly the same, it would not be easy for a pragmatist to find the difference.
ReplyDeleteThis von Mises article claims to explain ABCT.
ReplyDeletehttp://mises.org/daily/672
Only problem is that it totally fails to explain why artificially low rates of interest leads to any sort of CYCLE, rather than to employers simply investing more than is optimum, with the system attaining a new EQUILIBRIUM.
And the article is written by someone with a PhD in maths. I always though one needed brains to get a PhD in maths.
Ralph:
ReplyDelete"Only problem is that it totally fails to explain why artificially low rates of interest leads to any sort of CYCLE, rather than to employers simply investing more than is optimum, with the system attaining a new EQUILIBRIUM."
Sigh, the essence of the ABCT is not that resources are invested at less than "optimum", it's that resources are invested in UNSUSTAINABLE projects in the real sense, because the amount of real capital simply isn't there, but investors are misled into thinking it is there because of the artificially low interest rates sending false signals. In an unhampered market, lower interest rates signal more real savings is taking place. In a market with a central bank, the central bank lowering interest rates through monetary manipulation doesn't signal more real savings are taking place.
Is this a universal attribute of opponents of Austrian economics? To not understand it?
Pete, I plead guilty to not reading that von Mises article carefully enough: the author does give a reason as to why a cycle might arise. But I still don’t buy the argument. In particular, I don’t accept (in your words) that “the amount of real capital simply isn't there”. The von Mises article puts the same point indifferent words far as I can see. My reasons are thus.
DeleteFirst I’ll assume a typical present day economy, rather than a Robinson Crusoe economy or a gold standard economy.
I agree with Austrians that fractional reserve banking enables banks to create money out of thin air and lend it out, and that this brings an artificially low rate of interest. Plus that obviously induces employers to invest more than they otherwise would.
However, assuming the economy is already at full employment, the extra demand that that extra investment represents will result in excess demand which means inflation will start to loom. The relevant central bank / government will react by cutting demand (e.g. by raising taxes and/or interest rates), and that FORCES reduced consumption on the population at large.
In short, I suggest that Austrians are incorrect to say that resources are not there to fund the superfluous investment. The resources are there: they come from those forced to reduce consumption.
And that means the amount of superfluous investment can rise to a new equilibrium, and just stay there ad infinitum.
The whole 'real capital isn't there' is boggus and only works in fantasy world of 'austrian economics' which constantly mix up the stocks & flows of financial capital with the stock & flows of real assets. You can't consume more than what you can produce, you can't import things from the future, that's axiomatic, it's a fact of reality based on physical laws.
DeleteIf you try to consume more than what you produce, prices will rise. So inflation works just as a barrier to consumption (because saver and/or as an incentive for investment (to lower prices).
All that apart of the morals of the story and/or how desirable or pernicious that is.
Ralph, very funny, you have just described ABCT w/o actually realizing it. When you say "inflation will start to loom", that's the boom. When you say "government will react by cutting demand", that's the bust. But yes, the stealing via reduced consumption goes on ad infinitum, hence the permanent unemployment, lower wages etc.
Delete(1) this analysis ignores interpretation trade. They are a vast number of countries at any one time ready to supply factor inputs, raw materials or capital goods, if you have supply problems at home.
Delete(2) the boom will produce real capital goods investments, amongst other loans, such as to consumers. Whether each individual capital goods investment will be successful and will earn a profit is separate question, and just because interest rates rise, it does not mean all investments entered into at the lower interest rate suddenly get abandoned.
If there is a mutual expectation that a particular investment might deliver future profit by the bank and business, it is normal for businesses to refinance their investment loans or have the loans rolled over by banks.
If these capital goods investment investments turn out to be profitable they will increase the stock of real wealth.
Anonymous, I agree with Austrians that fractional reserve creates excessive amounts of credit / money and that that results in artificially low interest rates. However I don’t agree that when government cuts demand “that’s the bust”, as you put it. A competent government will cut demand by just enough to bring as high a level of employment as is consistent with acceptable inflation (2% or whatever). I.e. there is no need for a bust.
DeleteLord Keynes, Re your point No.1, if excess demand is met from abroad, that just depresses the relevant country’s currency on forex markets, which brings the balance of payments back into balance, which makes those imports uneconomic. I.e. it is reasonable to make the “closed economy” assumption here.
At the very least, it is worthwhile sorting this problem out on the closed economy assumption, and then looking at open economies to see if that changes anything (which I don’t think it does).
Point No.2: Agreed. I always find the Austrian idea that we have to sit around for years while malinvestments are corrected to be bizarre. E.g. the surplus houses built prior to the crunch can just be left empty, or be bulldozed. Those surplus houses do not prevent the workforce being employed performing other jobs. And the evidence in the U.S. is that construction employees have found no more difficulty finding alternative jobs that those made redundant in other industries.
I’ll do a post on this on my own blog in a day or two.
"Re your point No.1, if excess demand is met from abroad, that just depresses the relevant country’s currency on forex markets, which brings the balance of payments back into balance, which makes those imports uneconomic."
DeleteAnd what if the nation has a large trade surpulus, which is merely reduced somewhat?
The factors causing moments of the value of currencies go well the trade balance/current account and involve the capital account too.
E.g., Australia has run large current account deficits for many decades but its currency has been appreciating sharply in recent years.
Ralph, I think I must agree with you, malinvestments by itself do not seem to generate business cycle. After all, if they did, government spending would generate business cycle too, what with it being inherently one big malinvestment.
DeleteIn other words, if governments regulate fractional reserve banking properly, there should be no danger of business cycle. There would "merely" be permanent stagflation as in eg Japan's case.
Anon, I support full reserve, but I agree that a well regulated fractional reserve system is not a bad system. However I think fractional reserve (well or badly regulated) brings a permanent artificially low rate of interest.
DeleteI don’t agree that government spending is one big malinvestment. For example European health care systems, like the NHS, are more efficient than the American largely private system. And the most catastrophically wasteful form of economic activity we’ve had in recent years was the behaviour of private sector banks prior to the crunch.
A purely fixed money supply (gold standard) and a ban on FRB would not help the economy. Basic mathematics indicates that when an economy grows the money supply needs to expand and prices may need to go up. In your system there would be an even greater consolidation of resources, as there was during the Gilded Age. Some economists believe this massive inequality was part of the reason for the GD.
DeleteBubbles could also exist in a gold standard. Have you heard this analogy? I believe it is from Arnold Kling. Say you're in a restaurant, and there are two different types of items. Some items can be made quickly using stir-fry or a microwave. Some items, such as stews, have to be boiled on a range or put in the oven like a turkey. The extent to which customers are hungry or willing to wait determines what they order. However, a central planner can enter the picture and trick the cooks into thinking that people want more of the food that takes longer to cook than they truly desire. This creates the "boom" in preparing meals that take long to cook, followed by a "bust."
Now imagine the same scenario where the chefs have many different recipes they try. Many will not be popular, but some will result in exponential progress. When the CHEFS (business men) become optimistic, they try new recipes, thus creating a boom.
The first explanation is the Austrian position. The second is how the economy works. Sometimes people will get excited about a product, those industries will control all the capital technology, an artificial boom occurs that could create a recession if it is not handled properly.
Think of the dot com boom. That was an example. The response of the Austrians is also incorrect. The Austrians say that we should do nothing and let the market return to market clearing prices. This is a bit like saying that we should deny a drunk who's fallen into a lake blankets and stimulus on the grounds that his original problem was that he was too warm.
--Successfulbuild
Full reserve banking does NOT preclude an expanding money supply: the central bank can or would expand monetary base in accordance with the needs of the economy. Indeed, Positive Money, an organisation that campaigns for full reserve, devotes a lot of effort to considering exactly what should be done with the “new money” (which is not suggest I agree with everything PM has to say).
DeleteDear Ralph Musgrave:
DeleteIs this something like what Milton Friedman advocated:
"Friedman, in contrast, like Keynes was opposed to the gold standard. He wanted all bank deposit currency to be backed 100 percent by state-issued paper money. (4) This, Friedman believed, would put the money supply completely under the state’s control, and thus would make it possible to centrally plan a steady rate of growth in the money supply. If this were done, Friedman held, the “business cycle”—industrial cycle—would all but disappear. Exactly how the creation of various forms of credit money by the business community would be eliminated—especially if so-called “libertarian” free market policies are to be followed—is not explained by either the Friedmanites or Austrians.
The Austrians accused Friedman of inconsistency. The University of Chicago economics professor who hated every other form of central planning advocated a most strict form of central planning of the money supply. The more consistent Austrian economists instead believe the quantity of money must like all other economic variables in a “free economy”—that is, a capitalist economy—be decided by profit-driven private initiative."
http://critiqueofcrisistheory.wordpress.com/responses-to-readers-austrian-economics-versus-marxism/a-new-gold-standard/
(It should be pointed out that Rothbard's system would require even more government control than Friedman's, so I'm not sure of the accuracy of that blog. Nonetheless I enjoyed reading this entry:
http://critiqueofcrisistheory.wordpress.com/responses-to-readers-austrian-economics-versus-marxism/are-keynes-and-marx-compatible/are-marx-and-keynes-compatible-pt-4/
as it also gets into US imperialism. That seems like a pretty good blog.)
--successfulbuild
A purely fixed money supply (gold standard)
DeleteLet me stop you right here. If gold is the money commodity, then gold production expands the money supply. The quantity of gold available for human use increases every year.
In fact, gold production tends to be countercyclical - even moreso when it is money - so the revaluation of capital within a crisis coincides with an increase in the total supply of money. These two factors set the stage for another boom, once everything bottoms out and people start dishoarding.
I'm not an advocate of a return to the gold standard, but that much should be clear if we're to have an honest discussion about it.
Anon, You are right about Friedman: he did advocate full reserve. See p.247 (Item No.1 under the heading “The Proposal”) here:
Deletehttp://nb.vse.cz/~BARTONP/mae911/friedman.pdf
David:
ReplyDelete"Outside full general equilibrium, the natural rate is not well defined, and even if we knew what it was (i.e., the rate in full GE), it would not necessarily be the appropriate interest rate for an economy not in a state of full general equilibrium."
David, the interest rates that are "appropriate" are not the rates that you prefer, nor are they the rates that some centralized printing machine prefers. The rates that are "appropriate" are the rates that exist in an unadulterated, unhampered price system where individuals are free to value according to their own subjective value scales. Only then can individuals coordinate their own plans and other individual's plans. This is the case in "general equilibrium" or any other conceptual statis that one wishes to label the economy as currently "in." It is true for 1% employment or 100% employment. 99% idle resources or 0% idle resources.
The rates of interest that exist will be determined by the rates of profit. The rates of profit (and loss) are the constraint that coordinates resources and labor to their most urgently needed uses.
"The rates of interest that exist will be determined by the rates of profit. The rates of profit (and loss) are the constraint that coordinates resources and labor to their most urgently needed uses."
ReplyDeleteTime preference theories of the interest rate are invalid, unsound and flawed.
The rate you might demand for lending real goods or services is not necessarily the rate you would demand for lending money.
Nor does the monetary interest rate necessarily convey any information about what precise resources are available in the economy for new capital goods investments. Whether the required factor inputs at any particular time are available is an empirical matter.
When Mises said "crash", he was referring to the economy, just like he was referring to the economy when he used the word "crash" here:
ReplyDelete"It is necessary to realize that the price premium is the outgrowth of speculations anticipating changes in the money relation. What induces it, in the case of the expectation that an inflationary trend will keep on going, is already the first sign of that phenomenon which later, when it becomes general, is called “flight into real values” and finally produces the crack-up boom and the crash of the monetary system concerned." - pg 544, Human Action.
and
"The longing for security became especially intense in the great depression that started in 1929. It met with an enthusiastic response from the millions of unemployed. That is capitalism for you, shouted the leaders of the pressure groups of the farmers and the wage earners. Yet the evils were not created by capitalism, but, on the contrary, by the endeavors to “reform” and to “improve” the operation of the market economy by interventionism. The crash was the necessary outcome of the attempts to lower the rate of interest by credit expansion. Institutional unemployment was the inevitable result of the policy of fixing wage rates above the potential market height." - Ibid pg 853.
and
"The economist knows that such a boom must result in a depression. But he does not and cannot know when the crisis will appear. This depends on the special conditions of each case. Many political events can influence the outcome. There are no rules according to which the duration of the boom or of the following depression can be computed. And even if such rules were available, they would be of no use to businessmen. What the individual businessman needs in order to avoid losses is knowledge about the date of the turning point at a time when other businessmen still believe that the crash is farther away than is really the case." - Ibid pg 870-871.
Highly incorrect.
DeleteWords are abstractions. I can say, "I crashed my car." "I crashed here tonight." The use of the word depends on the context. You cannot infer one context from an entirely different context.
I cannot say that the statement "I crashed at his place" means I beat up an apartment solely because I said "I crashed the motorcycle" at another time when it was clear I meant the destruction of something.
You have to prove that that was the context, and it is not clear at all. Furthermore, how do we know that Mises even said this? All we have is hearsay, not real evidence.
--successfulbuild
Incredibly wrong.
DeleteWords are abstractions. I can say, "I crashed my car." "I crashed here tonight." The use of the word depends on the context. You cannot infer one context from an entirely different context.
The context of Mises' statement is the larger economy, not a single bank.
You have to prove that that was the context, and it is not clear at all.
Of course it's clear. Only those looking to find the smallest excuse to deny Mises of his profound genius and ability to foresee crises would claim that by "a great crash" he was referring to something other than the economy.
A bit off topic: I’ve just noticed a howler in a book which attempts to explain ABCT. It’s Huerta de Soto’s “Money, Bank Credit and Economic Cycles” (its free on the internet).
ReplyDeleteHe claims that GNP should not be obtained by toting up just FINAL OUTPUT, but that purchase or sale of INTERMEDIATE goods should be included. E.g. the sale of steel by steel producers to car maker should be added.
That’s under the heading “Criticism of the Measures in National Income Accounting” (p.305). Is he round the twist or have I misunderstood what he is saying?
The Austrians think that measures of national output should include intermediate goods, though this can be criticised as double counting:
Deletehttp://socialdemocracy21stcentury.blogspot.com.au/2012/01/austrian-substitutes-for-gdp-they-are.html
Yes, I think that's basically accurate. To the extent that our money flow measures are attempts to measure some kind "total economic activity," we should include the intermediate flows as well. It's not double-counting... for a simple production structure of N stages, it would be something like N-counting.
DeleteIf someone wanted to, they could affect these stats by churning around goods and money in a cycle, so you'd still need some structural knowledge of the sector or industry your trying to measure.
Aside from cycles, the double-counting objection is not really applicable. The economist who uses these measures will double-count both period 1 and period 2 and then talk about the difference (slowing activity, etc).
Marris, Let’s get this straight. Say there is a widget factory where the final stage in the production process is to paint the widgets, which is done in a special paint shop building. One day there is a management buy-out of the paint shop, but they continue just as before: painting the widgets, and selling them on at the same price as before.
DeleteAnyone with some common sense can see that nothing much has changed. Certainly neither national income or output have risen. And your “total economic activity” has not risen. But according to Austrians, national output or income or something HAS risen (by the total amount the new paint firm pays for unpainted widgets).
God first makes mad….
"Basic mathematics indicates that when an economy grows the money supply needs to expand and prices may need to go up."
ReplyDeleteBasic economics indicates that an economy is not something that "grows" autonomously. In fact, even attempts to define "growth" are very interesting to the point of being funny. And even meaningful growth does not require money supply to expand. What it requires is for real savings to expand. And that does not mean "real goods and services". It means that people need to forsake consumption today in favour of future consumption, thus freeing money thus saved for being offered as advances to owners of factors of production. Such a process could (and in all probability would) be accompanied by falling prices rather than rising prices. So your justification for FRB makes no sense.
(1) "In fact, even attempts to define "growth" are very interesting to the point of being funny."
ReplyDeleteOh, really? So Austrian measures of real output growth like Rothbard’s Gross Private Product and Mark Skousen's Gross Output are just symptoms of idiocy, are they?
http://socialdemocracy21stcentury.blogspot.com.au/2012/01/austrian-substitutes-for-gdp-they-are.html
(2) "What it requires is for real savings to expand."
That is not even true. An economy could in principle import all its factor inputs for production and excess consumption goods, and achieve growth, with no decrease in domestic consumption.
(3) "It means that people need to forsake consumption today in favour of future consumption, thus freeing money thus saved for being offered as advances to owners of factors of production."
Just because people have foregone some goods and saved money, it does not mean that necessary factor inputs or new consumption goods for workers in new investments have been saved. This is an absurd assumption that requires all goods - capital goods and consumption goods - to be homogenous and substitutable.
(4) "So your justification for FRB makes no sense."
The justification for FRB is that contrary to Austrian stupidity it is neither fraudulent nor immoral.