Paul Krugman wrote..."Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?"I have read several responses to this, but none resonated with me.Can anybody give me a response in layman's terms?I'm new to the topic of austrian economics.I have only read "Meltdown" by Thomas Woods and "Economics In One Lesson" by Henry Hazlitt.
http://mises.org/daily/3579
From that article:
"Did you spot the fallacy? When the investment boom collapses, people may shift spending to consumer goods. It doesn't at all follow, though, that a boom in consumption goods will result. A consumption boom, one presumes, means an increase in the quantity of consumer's goods; and no reason has been advanced to expect such an increase. All we have been given is that spending on consumer goods has increased. This may well simply increase the prices of these goods rather than expand production."
This is a rather funny claim for Krugman to make, considering that he's a Keynesian. You see, Keynesians use various arguments against traditional neoclassical economics like sticky wages and prices (the idea that wages and prices don't change instantaneously to equilibriate supply and demand) as well as monopoly competition (the idea that many firms have some monopoly power and thus can dictate prices to an extent - e.g. the grocer on your street corner). Using these Keynesian microfoundations, we discover that Krugman is wrong. After all, a temporary slump in investment good spending would mean increased unemployment in this sector due to sticky wages and prices. This increased unemployment would work to reduce consumption spending, since these newly unemployed workers would no longer be able to spend their money on consumption goods.
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JosephBright: http://mises.org/daily/3579 From that article: "Did you spot the fallacy? When the investment boom collapses, people may shift spending to consumer goods. It doesn't at all follow, though, that a boom in consumption goods will result. A consumption boom, one presumes, means an increase in the quantity of consumer's goods; and no reason has been advanced to expect such an increase. All we have been given is that spending on consumer goods has increased. This may well simply increase the prices of these goods rather than expand production."
Well, technically, this doesn't answer Krugman's critique. Krugman is not talking about the number of units of consumer goods sold he is talking about *income* (measured nationally as GDP). And every dollar I spend on consumer goods will be an additional dollar of income recieved by consumer goods manufacturers regardless of how many units they sell me for that additional dollar. Krugman's point is essentially that falling interest rates explain why the composition of spending/income shifts from investment to consumption goods, but it doesn't explain why the LEVEL of spending/income drops. In other words, Krugman is saying that a simple shift from investment to consumer goods doesn't explain why would we have a recession.
I think a more appropriate Austrian response to your question MDay1985 would be that what Krugman is ignoring is the impact malinvestments have on the capital structure and how this impacts total output. If you read some of Roger Garrison's work, like this essay, you will see that Austrians believe that spending on BOTH investment and consumer goods increases during the boom and that this has a nasty consequence on the capital structure. Specifically, increased consumer spending leads capital resources to be shifted toward the late stage production of consumer goods, while at the same time, lower interest rates leads to capital resources being also shifted to earlier stages of production. Middle stages are neglected and capital there may actually depreciate without replacement.
In the end, we are left with a capital structure that is out of whack as resources are tugged to early and late stages of production. As Garrison puts it: " Outputs of earlier stages feed successively into subsequent stages. At some stage in this process, the viability of the policy-induced capital restructuring comes into question. Capital and labor resources complementary to those already committed to earlier stages are in short supply (Hayek, 1967, pp. 85-91)."
As result , we simply can't produce as much as we used to produce until it brought back into alignment (the production possibilities frontier has contracted). As a result, the LEVEL of income falls and we have a recession. If you want to think about it another way (a way that Garrison does not use but makes sense to me), the amount of capital in the economy may have stayed the same or even increased during the inflationary boom. But because the inflationary boom led to a realignment of the entire capital structure we no longer have the right KINDS of capital to produce the same amount of goods as before the boom. This essentially represents a productivity shock that reduces aggregate output. And this productivity shock will last so long as the capital structure is out of sorts.
At least, that's how I understand it. Of course, I should note that I do not think the ABCT is very convincing for other reasons not mentioned in the Krugman quote. So anyone, please feel free to correct me if anything in my description above is wrong.
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MDay1985: Paul Krugman wrote..."Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?"I have read several responses to this, but none resonated with me.Can anybody give me a response in layman's terms?I'm new to the topic of austrian economics.I have only read "Meltdown" by Thomas Woods and "Economics In One Lesson" by Henry Hazlitt.
Say an earthquake wipes out every last farm in the USA, as well as all the ways to import food, like shipping etc. The country is obviously in deep trouble, since there is no food. Enter Paul Krugman. "Fear not. What people don't spend on food they will spend on televisons. The money has to go somewhere. The economy is still hale and hearty, despite the fact that everyone is starving to death."
The point is, how much money is passing hands doesn't really tell you much about the state of the economy. The wealth of a nation is its resources, not its dollar bills. If those resources are destroyed, or what is the same thing, wasted, the country is poorer.
A false boom is a waste of resources. They are going into making stuff nobody really wants. When this hits home, meaning when the waster doesn't make his expected profits, he stops. He fires everyone who was working for him. They have a hard time finding jobs, because the country is poorer, having less resources at its disposal. It takes a while for things to be rearranged towards using what resources are left in a more productive manner. That time interval is the recession.
"Ah, but the money is still flowing freely," say Krugman. So?
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Real wealth and real monetary value is created and/or acquired ONLY when the members of a family (or a nation, tribe, city-state, etc.) plant, grow and/or harvest something of commercial value from the earth, extract something of commercial value from the earth, provide professional services (medical, legal, dental, engineering, architecture, accounting, land surveying, technology, etc.) to others outside of that family, and/or manufactures or constructs something of commercial value that is consumable (or permanently useful for income or rent) and then SELLS, LEASES OR RENTS these items and/or services to parties outside of their family, IN RETURN FOR A NET TRANSFER OF GOLD, CURRENCY OR COMMODITIES from other parties outside of their family into their own family. The members of that family can reflect their real wealth with the accumulation of grain, gold, cattle, jewels, land, buildings, commodities and/or other marketable products for reserve use in times of emergency and/or also to raise the standard of living for the members of that family. US government policies encouraged the US companies to cease making things for US consumption and export in order to generate national wealth, and instead to import these consumer items in exchange for titles to existing US wealth such as privately owned land, hotels, farms, businesses, casinos and other assets located in the USA that were created by previous generations of US citizens transferred to the foreign nations that elected to industrialize and generate wealth by making and exporting consumer items to the USA. Did the Biblical Jacob squander his assets unwisely and then became hungry when a famine occurred? Did Jacob sacrifice all of his cattle to his god? Or sell his assets for food & wine to have a bunch of parties? Did Jacob burn his tents, grain and other assets as sacrifice to his god? When the Jacob's family faced starvation, Jacob took his family to Egypt where there was grain stored and hoarded by the greedy Egyptians to insure the survival of Egyptians during times of drought and famine. Jacob and his descendants probably submitted themselves to be slaves of the Egyptians in return for food and shelter. Is the US government repeating these actions?
Real wealth and real monetary value is created and/or acquired ONLY when the members of a family (or a nation, tribe, city-state, etc.) plant, grow and/or harvest something of commercial value from the earth, extract something of commercial value from the earth, provide professional services (medical, legal, dental, engineering, architecture, accounting, land surveying, technology, etc.) to others outside of that family, and/or manufactures or constructs something of commercial value that is consumable (or permanently useful for income or rent) and then SELLS, LEASES OR RENTS these items and/or services to parties outside of their family, IN RETURN FOR A NET TRANSFER OF GOLD, CURRENCY OR COMMODITIES from other parties outside of their family into their own family. The members of that family can reflect their real wealth with the accumulation of grain, gold, cattle, jewels, land, buildings, commodities and/or other marketable products for reserve use in times of emergency and/or also to raise the standard of living for the members of that family. US government policies encouraged the US companies to cease making things for US consumption and export in order to generate national wealth, and instead to import these consumer items in exchange for titles to existing US wealth such as privately owned land, hotels, farms, businesses, casinos and other assets located in the USA that were created by previous generations of US citizens transferred to the foreign nations that elected to industrialize and generate wealth by making and exporting consumer items to the USA.
Did the Biblical Jacob squander his assets unwisely and then became hungry when a famine occurred? Did Jacob sacrifice all of his cattle to his god? Or sell his assets for food & wine to have a bunch of parties? Did Jacob burn his tents, grain and other assets as sacrifice to his god? When the Jacob's family faced starvation, Jacob took his family to Egypt where there was grain stored and hoarded by the greedy Egyptians to insure the survival of Egyptians during times of drought and famine. Jacob and his descendants probably submitted themselves to be slaves of the Egyptians in return for food and shelter. Is the US government repeating these actions?