“ No economic crisis and consequent recession hit when the lengthening of the stages in the productive structure, a process we studied in the last chapter, results from a prior increase in voluntary saving, rather than from credit expansion banks bring about without the backing of any growth in real saving. Indeed if a sustained rise in voluntary saving triggers the process, this saving prevents all of the six microeconomic phenomena which spontaneously arise in reaction to credit expansion and which reverse the artificial boom that credit expansion initially creates. In fact in such a case there is no increase in the price of the original means of production.The fatal problem underlying this analysis is that capitalist systems have historically had many periods when they are mired in underemployment equilibria where there are significant idle resources, like labour, raw materials, capital goods and other factor inputs.
On the contrary, if the loans originate from an upsurge in real saving, the relative decrease in immediate consumption which this saving invariably entails frees a large volume of productive resources in the market of original means of production. These resources become available for use in the stages furthest from consumption and there is no need to pay higher prices for them. In the case of credit expansion we saw that prices rose precisely because such expansion did not arise from a prior increase in saving, and therefore original productive resources were not freed in the stages close to consumption, and the only way entrepreneurs from the stages furthest from consumption could obtain such resources was by offering relatively higher prices for them” (Huerta de Soto 2006: 397–398).
If an economy with significant idle resources has investment via fractional reserve banking or central bank creation of excess reserves (without prior saving in loanable funds), how will these inflationary pressures happen if productive resources simply do not need to be freed in the stages close to consumption? Such factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries.
To see how ridiculously irrelevant ABCT is we only have to consider how the US economy and many other Western economies over the past 20 years have had significant idle resources and labour. In fact, the US has not really had full employment since the late 1980s, and much of the factor inputs can be bought overseas anyway.
This is another unrealistic assumption underlying ABCT: it assumes an economy with full employment, no unused capacity and no significant idle resources.
Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala
"it assumes an economy with full employment, no unused capacity and no significant idle resources."ReplyDelete
So does most of economics. That's why they keep redefining the term 'Full Employment'.
For me the only acceptable definition of Full Employment is when everybody who wants work has sufficient to allow them to live a life free of poverty.
Economist should then have to design their systems to that requirement. Not try and loosen the requirements to fit their models.
That's right LK, and that renders the ABCT invalid for almost all capitalist history!ReplyDelete
I would really like if you could refute Mises about ABCT, given he created it and for many Austrians it's still the most correct/consistent formulation of the theory.
I would really like if you could refute Mises about ABCT,ReplyDelete
If you give me the references in Mises' writings, I'll write a response.
I said that you were right, but that criticism does not apply to Mises version. He says:ReplyDelete
"At any rate, the immediate consequence of credit expansion is a rise in consumption on the part of those wage earners whose wages have risen on account of the intensified demand for labor displayed by the expanding entrepreneurs."
That does not assume full employment.
What is your source?ReplyDelete
There Mises explains his theory of the business cycles.
Lord Keynes, you ironically give the evidence that you never read Huerta de Soto (or at least not entirely). You can only fool those who never read and learn about ABCT. See what de Soto had to say, in his book (2006) :ReplyDelete
The theory of the business cycle teaches precisely that credit expansion unbacked by an increase in real saving will encourage the malinvestment of productive resources even when there is a significant volume of idle resources, specifically, unemployed labor. In other words, contrary to opinions expressed by many critics of the theory, full employment is not a prerequisite of the microeconomic distortions of credit expansion. When credit expansion takes place, economic projects which are not actually profitable appear so, regardless of whether they are carried out with resources that were unemployed prior to their commencement. The only effect is that the nominal price of the original means of production may not rise as much as it would if full employment existed beforehand.
Nevertheless the other factors which give rise to malinvestment and a spontaneous reversal, in the form of a crisis and recession, of the errors committed eventually appear, regardless of whether the errors have been committed with originally-unemployed resources.
An artificial boom based on bank credit expansion which reallocates previously-unemployed original means of production merely interrupts the process of readjustment of those factors, a process not yet complete. Consequently a new layer of widespread malinvestment of resources overlaps a previous layer which has yet to be completely liquidated and reabsorbed by the market.
Another possible effect of the use of previously-idle resources is the following: apart from the fact that their price does not increase as rapidly in absolute terms, they may make a short-term slowdown in the production of consumer goods and services unnecessary. Nonetheless a poor allocation of resources still takes place, since resources are invested in unprofitable projects, and the effects of the cycle eventually appear when the monetary income of the previously-unemployed original means of production begins to be spent on consumer goods and services. The relative prices of these goods and services rise more rapidly than the prices of products from the stages furthest from consumption, thus diminishing real relative wages and setting off the “Ricardo Effect” and the other effects which lead to crisis and recession. In any case credit expansion will always, from the outset, cause a more-than-proportional increase in the relative price of products from the stages furthest from consumption. This rise stems from the new monetary demand credit generates for these goods and from the artificial reduction in the interest rate, which makes such projects more attractive. This results in a lengthening of the productive structure, a change which cannot be maintained in the long run and which is completely independent of whether previously-idle resources have been used in some of such projects.
Austrian theory does not, as is often suggested, assume “Full Employment.” It assumes that in general, at any moment, some factors are scarce, some abundant. It also assumes that, for certain reasons connected with the production and planned use of capital goods, some of these scarcities become more pronounced during the upswing. Those who criticize the theory on the ground mentioned merely display their inability to grasp the significance of a fundamental fact in the world in which we are living: the heterogeneity of all resources. Unemployment of some factors is not merely compatible with Austrian theory; unemployment of those factors whose complements cannot come forward in the conditions planned is an essential feature of it. (Lachmann, Capital and its Structure, pp. 113–14)
De Soto, as in most of his work, talking nonsense.Delete
"In other words, contrary to opinions expressed by many critics of the theory, full employment is not a prerequisite of the microeconomic distortions of credit expansion. "
I've already made it clear that relative scarcities of factor inputs is a prerequisite of all forms of ABCT. The theory is also ridiculously flawed by its inability to model what happens in an open economy.
The development of any boom in the business cycle is dependent on a myriad of factors, and whatever future profit any particular capital goods project will deliver can only be a matter of subjective expectation in the present. A rise in interest rates may decrease the demand for credit and raise the burden of servicing debt, but, 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.
And I am perfectly familiar with the Lachmann quote you cite, thank you.
First, you've shifted from 'this guy isn't making sense' to 'ABCT is wrong'. Second, it's unclear to me what your argument is. Specifically, the paragraph starting with "If an economy with significant idle resources..." I really have no idea what you're trying to say here (which is rare, I've read a lot of your posts on this site and usually they're clear and persuasive). My best guess is it's something like "How could the inflation/malinvestment occur if there's all this capital that's idle? Won't it stay idle?"ReplyDelete
The only thing I can think to add which might be helpful here is that Austrians emphasize that capital is heterogeneous, so sure, there will always be idle capital--capital that can't generate profit. But that doesn't mean there can't be inflationary pressure in the scenario you detail (FBR/excess reserves) while there's also idle capital, because if the idle capital doesn't get used, then the money supply increase would therefore just lead to inflation and an increase in malinventment.
Of course, much of the 'grey area/almost profitable' capital would get employed, but that would still mean malinvestment in the form of already existing unprofitable capital being employed (instead of the creation of new capital which would be, according to ABCT, 'higher-order' goods which won't generate as much profit as would be generated by investment in a Austrian-ideal-zero-malinvestment economy, though it may still generate a profit).
Why do investors make investments that will go under?ReplyDelete
Are they fools?
It seems to me that the obvious criticism that the FED is making too much money is simpler and more valid - if there is too much money, you get inflation!