Paul Krugman offers his take of Austrian Economics in regards to Robert Murphys Post "The Importance Of Capital Theory." What do you think?
January 19, 2011, 9:49 am
I’ve been watching with sympathy as David Beckworth and Scott Sumner discover that their updated monetarism actually puts them on my side of the great ideological divide — cast into the outer darkness along with John Maynard Keynes and Milton Friedman.
But what does the other side believe? Someone, I don’t know who at this point, sent me to this post by Robert Murphy, which is the best exposition I’ve seen yet of the Austrian view that’s sweeping the GOP — and I mean that sincerely, never mind the puerile insults aimed at yours truly. As regular readers know, I’m a stylized-example kind of guy, and Austrians tend to prefer lots of words instead; but in this case Murphy does offer a little story that is, in a way, a counterpart to my story about the baby-sitting coop (although my story was based on an actual real-world example).
So what is the essence of this Austrian story? Basically, it says that what we call an economic boom is actually something like China’s disastrous Great Leap Forward, which led to a temporary surge in consumption but only at the expense of degradation of the country’s underlying productive capacity. And the unemployment that follows is a result of that degradation: there’s simply nothing useful for the unemployed workers to do.
I like this story, and there are probably other cases besides China 1958-1961 to which it applies. But what reason do we have to think that it has anything to do with the business cycles we actually see in market economies?
I’ve already pointed out the problems, both logical and empirical, with the claim that workers are unemployed because they have zero marginal product. But there are many more problems with the notion of a recession as a supply shock.
A short sample: If inflation is a case of too much money chasing too few goods, why aren’t slumps associated with accelerating rather than decelerating inflation, as the supply of goods falls? Why is there such a strong correlation between nominal and real GDP? Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow? And on and on.
Oh, and what evidence is there that the economy’s capacity is damaged during booms? Investment rises, not falls, during booms; yes, I know that Austrians take refuge in cosmic talk about the complexity of production and how measured investment may not show what’s really happening, etc., but where’s the positive evidence of what they’re claiming?
The point is that the real world looks a lot like the one Keynes and Friedman envisioned, in which the demand side drives the business cycle. Why should anyone be determined to throw away 75 years of economic thought, to believe that these appearances are deceiving? Why the insistence on taking an intellectual Great Leap Backward?
Well, at that point we’re into talking about the essentially political nature of this thing. Maybe another time.
Update: In case you’re wondering, no, I haven’t changed my view of Austrianism. If I say it’s interesting, well, I’d say the same thing about the phlogiston theory of fire.
Here is a man without intellectual curiosity whatsoever.
The fallacies of intellectual communism, a compilation - On the nature of power
Why is there such a strong correlation between nominal and real GDP?
Because price inflation has typically been close to zero. The closer it is to zero, the closer the correlation. At 0%, it's an exact correlation, obviously. But there is historically a negative correlation between real GDP growth and price inflation with any CPI increases > 1.8% annually.
i think boettke sums up my feelings:
None of what I have said means that Krugman is wrong to demand answers of an empirical nature from those who put forth the Austrian perspective on boom and bust. Those following the Austrian approach need to answer Krugman...This is just the way of economic debate, and those of the Austrian persuasion ought to be able to persuasively respond to Krugman's challenges, just as they ought to respond to the criticisms of Cowen, and Caplan, and Tullock, and Yeager, etc. As Deirdre McCloskey often stresses, empirical questions demand empirical answers, and cannot be answered philosophically. http://austrianeconomists.typepad.com/
None of what I have said means that Krugman is wrong to demand answers of an empirical nature from those who put forth the Austrian perspective on boom and bust. Those following the Austrian approach need to answer Krugman...This is just the way of economic debate, and those of the Austrian persuasion ought to be able to persuasively respond to Krugman's challenges, just as they ought to respond to the criticisms of Cowen, and Caplan, and Tullock, and Yeager, etc. As Deirdre McCloskey often stresses, empirical questions demand empirical answers, and cannot be answered philosophically.
http://austrianeconomists.typepad.com/
Ambition is a dream with a V8 engine - Elvis Presley
A clever guy like Krugman deserves someone more sophisticated than me, but I'll give it a shot. As always, my comments in bold:
First 2 paragraphs are just talk, so we go straight to:
It would be nice if actually read some AE, as opposed to making up what you think it says
Two reasons. First, history bears us out. Read Americas Great Depression by Rothbard, and other works which show this. After all, the first requirement of equating AE with phlogiston is to actually know what AE says, right?
Second, you yourself, all you Keynesians admit it, though of course you don't realize it. You admit that every bust has a boom that precedes it. You admit that every bust has factories etc. not working at full capacity. Which means [though you don't grasp this point], that those factories should not have been built so large in the first place. They were built to supply a demand that doesn't exist. So why were they built at all? The foolishness of the boom did that. Well, what's going to happen to workers in those factories? They will be laid off. What's not to understand?
Who said a recession is a supply shock [=an event that suddenly changes the price of a commodity or service]? A recession is when people get laid off because they had unproductive jobs. Where did you see anything different in Murphy's article?
A short sample: If inflation is a case of too much money chasing too few goods, why aren’t slumps associated with accelerating rather than decelerating inflation, as the supply of goods falls?
The basic answer here is that all slumps have [price] inflation that accompanies them. They should all be called stagflations. The ones that don't are "lucky", in that demand drops so much more sharply [you should know that, as a Keynesian], because of the incredible unemployment that goes with them.
Are you saying that Argentina and Zimbabwe have high employment? Every country that has high inflation has high unemployment. The two go hand in hand.
First, let us agree that GDP just measures spending. That's what it counts, how much money was spent. Nothing else. The use made of GDP to deduce growth is not what GDP measures. It is a deduction from GDP.
Now that we agree on that, we must agree that real GDP [=adjusted for inflation] must always be zero, as shown in this article.
Having agreed on that, we must agree that the numbers for real GDP that are non zero are just fiction. So you are asking why do some fictional numbers follow a pattern? Who knows, who cares? Maybe because they were invented for that very reason.
Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow? And on and on.
Where did you see that AE disputes this?
Oh, and what evidence is there that the economy’s capacity is damaged during booms?
The bust that follows, silly.
Investment rises, not falls, during booms;
Ah, Watson, but are the investments in the right places? No they are not. Which will lead to the bust.
The truth is, if you think "investment rises, not falls, during booms" is somehow relevant to a discussion of AE, then you have shown yourself completely clueless about AE. You missed the boat in Murphy's parable, excuse the pun.
yes, I know that Austrians take refuge in cosmic talk about the complexity of production and how measured investment may not show what’s really happening, etc., but where’s the positive evidence of what they’re claiming?
Huh? AE says that investments are made in the wrong places. Like those factories that cannot work at full capacity once the bust comes [which a s a loyal Keynesian, you admit exist]. Or those dot.com stocks, or housing.
I'm not sure why you don't get this, Paul.
The point is that the real world looks a lot like the one Keynes and Friedman envisioned, in which the demand side drives the business cycle.
On the contrary. In a Keynesian Friedmanian world, Zimbabwe would be the richest nation on Earth.
Why should anyone be determined to throw away 75 years of economic thought,
Awww, you know better than that, Paul. A silly argument like that was made against Copernicus, and Einstein, and every discoverer of truth.
to believe that these appearances are deceiving?
They are not deceiving anyone. Read Austrian books on economic history [with an open mind of course] and thine eyes shall be opened.
Why the insistence on taking an intellectual Great Leap Backward?
I bet that's what Pravda wrote when the Soviet Union wanted to go back to Capitalism.
The rest of the article contains nothing of substance.
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It's easy to refute an argument if you first misrepresent it. William Keizer
Ouch. Cowen pops in with a killer right hook (keeping with Murphy's metaphor of this being like a boxing match). To explain the comovement between investment and consumption, Murphy and Garrison both rely on the notion that maintenance of capital in the middle stages of production decline. However, as Cowen notes, the evidence available seems to indicate that capital maintenance actually moves with investment and consumption (and represents only a small portion of GDP anyways...at least in Canada).
The most careful study I could find, based on Canadian data, shows that investment and capital maintenance move together in the same direction. This piece argues for countercyclical maintenance expenditures, but not on the basis of any actual evidence. In any case, how much is capital maintenance as a percent of gdp anyway? Here is one earlier Canadian estimate of about six percent. Will variations in that sum -- with conversion time -- be enough to support a consumption boom? With expanding capital investment, a full employment assumption, and a basic closed economy model? I doubt it.
Not good news. It will be interesting to see how Murphy responds.
PS* Simply saying "well, we don't know if that maintenance was on the right kinds of capital" really won't cut it in an academic debate unless you can provide evidence that would indicated that the capital being maintained was indeed not the correct kind.
The comovement of investment and consumption is actually a vital part of the ABCT. The entire point of a "boom" is that something is being done in excess - and according to Austrians that thing is the consumption of scarce resources. There's a reason why Austrian economists have about three hundered billion metaphors regarding brick-laying for a house when there isn't enough bricks to finish the house and all other kinds of shenanigans. The point being made is that an economy cannot expand its capacity for both investment goods and consumption goods without prior investment, which requires savings (the negation of consumption). Maybe if you read some Mises you could understand this.
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Smiling Dave,
I think you really need to re-think some of your arguments in your post (both substanatively and sylistically, as I think implying Krugman is the dim Watson to your insightful Holmes is probably a bit much). But I just want to respond to one part in particular.
I think Krugman's description is perfectly defensable. If I am correct, Krugman is referring to the fact that Austrians claim that an artificial credit expansion will distort the capital structure and result in the economy not being able to produce as much as it could before the boom. This is the essense of a supply shock.
If I wanted to flatter myself (and I do), I would argue that Paul Krugman saw and was convinced by my description of the ABCT in the post I wrote criticising his Slate article. I will repeat it below so you can have a better idea of where PK and I are comming from (PS* he asked me to call him PK from now on).
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. http://mises.org/Community/forums/p/14157/300656.aspx#300656
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.
http://mises.org/Community/forums/p/14157/300656.aspx#300656
Student,
TY for your genteel reply.
Your post to PK Watson talked about a productivity shock. Is that the same as a supply shock?
In any case, it's not what you call it, it's what happens, right? So I'm willing to withdraw that particular piece you quoted until I know more about the formal language of economics.
krazy kaju,
as i mention in the post above, the important question is the *kinds* of investment being made. Austrians like Garrison would argue that an artifical boom will lead to the creation of new capital in the early and later stages of production, which would draw resources away from maintaining existing capital in the middle stages of production.
*That* is why if we thought ABCT accurately represented most recessions that we would expect capital maintenance spending to be falling in boom time relative to new investment. However, for whatever reasons, that apparently isn't what the data are telling us.
That is bad news because that is the *the* essential part for how ABCT explains output fluctuations that differentiates it from other theories. If the economy was not left with less of the "right kinds" of capital at the end of the boom, then it could just as easily produce the same mix of goods it produced before. So workers and other resources would move back toward those industries without any recession needed.
Now that isn't a silver bullet against ABCT. But it will be interesting to see how Austrians respond. I mean, at first I thought they could argue "hey, maybe maintenance on capital in the middle stages of production decreased but that was offset by an increase in maintenance spending at the early and late stages". But that doesn't make any sense. Why would depreciation suddenly increase for capital in those stages of production relative to the middle stages?
Anyways, interesting stuff.
I would say, depending on the context, all productivity shocks could be considered supply shocks, but not the other way around.
Productivity refers to the amount of outputs you can get from a given set of inputs (i.e. you become more productive when you can produce more with the same amount of inputs). If we ran out of oil tomorrow then we wouldn't be able to produce tires or fake christmas trees or many other things (at least not like we do now) and we'd see a huge drop in output. But I wouldn't call that a productivity shock. It would really be an "input shock", because we now no longer have the inputs to produce those outputs.
By contrast, if by magic all the electronics in the economy suddenly were replaced by similar electronics from 2005, I would say that was a productivity stock. We would have the same amount of inputs, but we would not be able transform them into outputs as efficiently.
I would call both "supply shocks" because they both impact the "supply-side" of the economy (the production of goods and services).
In any case, how much is capital maintenance as a percent of gdp anyway?
I seriously do not understand why anyone would listen to someone who said the above ^^.
GDP is arbitrary.
"A short sample: If inflation is a case of too much money chasing too few goods, why aren’t slumps associated with accelerating rather than decelerating inflation, as the supply of goods falls? Why is there such a strong correlation between nominal and real GDP? Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow? "
does gibberish like this really mean anything? i hope Bob Murphy reads this thread before he debates Krugman so he knows what he's going to be up against.
an Austrian debating this guy would be analogous to Steven Hawking debating a Rabbi from 2000 years ago about the origin of the universe.
You completely misunderstand the ABCT. The entire point isn't that resources are being misused, it's that they're being overused. The ABCT by no means requires that any stage of production shrink into accomadating expansion of other stages - the entire point is that unbacked credit expansion funds new investment projects (the malinvestments) which aren't sustainable for the very reason that they're competing for resources from previously established investment projects. These malinvestments are discovered as soon as consumers get their hands on the inflated money and reestablish their time preferences. However, in the case of continual credit expansion, this discovery takes significantly more time than from a singular credit expansion, and during this discovery, overconsumption occurs as consumers gradually get their hands on the inflated money.
everything i said in my earlier post came out of my reading roger garrison's work, though it could just have easily have come from bob murphy's sushi story that paul krugman linked to in the OP. similarly it meshes very well with what critics like tyler cowen and paul krugman were saying about ABCT. so as best i can tell there is nothing really orginal about what i said nor should there be anything controvertial (as economists on both sides seem to share the interpretation).
and really nothing i said contradicts what you said. you mention "over use" and "over consumption". think about what those terms mean (overconsumption compared to what?) . think also about how that consumption is funded (hint: its through what murphy calls capital consumption). i think that once you define for yourself the meaning of those terms you will find that we are saying the same thing.
anyways roger garrison has a lot of great online resources for better understanding these issues and how they relate to ABCT (he used to have a paper written toward intermediate undergrads that was especially great but it looks like he took it down). here is one article by him with excerpts that should sound familiar to you after reading my post.
The low interest rate that accompanies the boom phase of a credit expansion directs resources to the early stages of production. But at the same time, the increased demand for consumption goods is accompanied by an increased (derived) demand for resources in the very late stages. Resources are pulled in that direction, too. For a time both kinds of policy-induced misallocations can occur, as depicted as a double distortion of the Hayekian triangle. The misallocation of resources (both malinvestment and overconsumption) shown in Figure 2 corresponds to the economy that has reached the hollow diamond point along the adjustment path that extends beyond the PPF. The Hayekian triangle shows resources being allocated away from middle stages of production in both directions. This movement would translate into Strigl's account of the unsustainable boom as increased consumption and increased long-term capital creation, both made possible, in part, by the undermaintenance of existing capital. ... Not far [into the boom phase] the limits imposed by scarcity become increasingly binding, but the low rate of interest continues to favor investment over consumption. At this point it does matter that the investment community gets the new money first. Resources continue to be bid into the early stages, while production processes that were in their middle stages at the beginning of the expansion—and from which resources were being misallocated at point 1—now begin to yield a declining volume of consumables. http://www.auburn.edu/~garriro/strigl.htm
The low interest rate that accompanies the boom phase of a credit expansion directs resources to the early stages of production. But at the same time, the increased demand for consumption goods is accompanied by an increased (derived) demand for resources in the very late stages. Resources are pulled in that direction, too. For a time both kinds of policy-induced misallocations can occur, as depicted as a double distortion of the Hayekian triangle. The misallocation of resources (both malinvestment and overconsumption) shown in Figure 2 corresponds to the economy that has reached the hollow diamond point along the adjustment path that extends beyond the PPF. The Hayekian triangle shows resources being allocated away from middle stages of production in both directions. This movement would translate into Strigl's account of the unsustainable boom as increased consumption and increased long-term capital creation, both made possible, in part, by the undermaintenance of existing capital.
...
Not far [into the boom phase] the limits imposed by scarcity become increasingly binding, but the low rate of interest continues to favor investment over consumption. At this point it does matter that the investment community gets the new money first. Resources continue to be bid into the early stages, while production processes that were in their middle stages at the beginning of the expansion—and from which resources were being misallocated at point 1—now begin to yield a declining volume of consumables.
http://www.auburn.edu/~garriro/strigl.htm
If I am correct, Krugman is referring to the fact that Austrians claim that an artificial credit expansion will distort the capital structure and result in the economy not being able to produce as much as it could before the boom. This is the essense of a supply shock.
I think it's a mistake to classify ABCT as either a "supply shock" or a "demand shock". It's both; it can especially be a demand shock due to the sudden mismatch of prices resulting from credit contraction (which represents a fall in aggregate nominal demand).
...everything i said in my earlier post came out of my reading roger garrison's work
This doens't have any bearing on what you said earlier (I actually would argue that ABCT is about a "misuse" of capital goods, not "overuse"—that's why Mises was adamant about using "malinvestment", not "overinvestment"), but I thought Garrison's Time and Money was poor. I think he overemphasizes the importance of some type of cohesive modelling between different macro theories, and fails to explain the Austrian theory well enough. If you haven't already (I don' know if you have), Hayek's work is better.
"Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow?"
Sounds like he understands that central banks create the Boom-Bust Business Cycle and because it is a proven method of creating the cycle, it should be continued. (As if this were a desired result!)
"Oh, and what evidence is there that the economy’s capacity is damaged during booms? Investment rises, not falls, during booms; yes, I know that Austrians take refuge in cosmic talk about the complexity of production and how measured investment may not show what’s really happening, etc., but where’s the positive evidence of what they’re claiming?"
Austrians do not claim that the economy's capacity is damaged during booms or that investment falls during booms. Austrians claim that economic capacity is stunted in its growth by a rise in malinvestments. The man simply does not understand Austrian Economics at its most basic levels (my level). The positive evidence is called a "bust."
johnathan, i'm the opposite. i greatly prefer garrison's clarity of exposition. hayek really doesn't have that clarity and i think that has led to a great amount of confusion about what the fundamental aspects of his vision of abct actually were. for example, garrison obviously believes that income and consumption should increase in tandem during a boom (and contract together during a bust) and he sees this as being totally consistant with hayek. by contrast, murray rothbard's exposition of the abct predicts that that investment should rise relative to consumption and he also cites hayek (http://mises.org/rothbard/agd.pdf).
So I guess the real lesson i take away from my reading is that there isn't one "austrian business cycle theory", but multiple ones all sharing common roots. i think this is fair and not uncommon (there is really no such things as a singular "keynesian business cycle theory"). it just means one needs to be clear when discussing these issues and that really hasn't been done i think.
This quote worries me
...I’ve seen yet of the Austrian view that’s sweeping the GOP
I'm afraid that these type of labels will eventually serve to undermine our intelectuals. It would be better to remain a fringe movement without much publicity than to be labled some brand of "Republican-economics"--that is, unless the Republicans actually do start subscribing/implamenting such economics. I'm thinking our writers should do something quickly to distance ourself from the GOP. I can see it now,
"Well, according to Mises"
--"Mises...who cares about that right-wing crank...that Republican economist...etc."
Read until you have something to write...Write until you have nothing to write...when you have nothing to write, read...read until you have something to write...Jeremiah
*sighs*
So I know that I wrote an excellent reply, but I guess I forgot to post it? So I'll give you the cliff-notes of what I was saying, as I am too tired to retype the whole damn thing:
The ABCT doesn't require that the middle stage(s) of production deteriorate. In fact, if you use a Hayekian triangle to illustrate unsustainable growth, a la Roger Garrison in Chapter 4 of Time and Money, you'll notice that the middle stages don't decline, it's the lower order and the higher order stages which increase, the point being that the unbacked credit expansion has caused unsustainable expansion in the lower order and higher order stages. There's no need for the middle stages to take a hit, in fact, investment in these stages might rise slightly due to lower interest rates. The unsustainable growth is revealed when workers/consumers get the money, re-establish their time preferences, and the higher order stages of production become unprofitable/less profitable. Workers then begin to get laid off from these higher order projects, which affects the rest of the economy as consumer spending takes a hit. There's a reason why initial jobless claims and the average manufacutor worker's workweek are considered leading indicators.
And, honestly, this discussion makes me doubt whether you are even familiar with ABCT, or whether you're just finding whatever you can on the internet to back up your previously held beliefs. So why don't you prove me wrong and explain ABCT using your own words? Not asking for a treatise; this can be done in two to three paragraphs.
krazy kaju:And, honestly, this discussion makes me doubt whether you are even familiar with ABCT
I don't think that is fair. Student has read just as much Human Action as PK.
The guy is posting parts of critiques by mainstream economists which are irrelevant, and acting as if they are some kind of ultimate destruction of the ABCT. Looking at words and reading comprehension are two entirely different things.
There's no need for the middle stages to take a hit, in fact, investment in these stages might rise slightly due to lower interest rates. The unsustainable growth is revealed when workers/consumers get the money, re-establish their time preferences, and the higher order stages of production become unprofitable/less profitable
this is how rothbard explains abct. this is not how garrison explains it. the words are the same, but the steps and concepts are different. rothbard makes a key assumption that investment (in the "higher order stages of production") rises relative to consumption. and that it is only once the income of the origincal factors increase and they attempt to increase their consumption that these investments are "revealed" to be bad ones.
http://mises.org/rothbard/mes/chap12f.asp#11B._Credit_Expansion_Business_Cycle
this is simply not the story that garrison is telling (and the fact you think it is really makes question whether you read and understood time and money).
the story garrison is telling is, i believe, the one i am telling. i have summarized my understanding of garrison in my own words and then quoted garrison at length to support that interpretation.
now you're asking me to describe abct in my own words like i have not already? the fact you appear to have forgotten key pieces of our conversation makes me think you're either fighting with senilty or fighting with me. in either case you're gonna nurse!!
hahaha nah, but seriously, i wont be re-re-summarizing my argument a third time. i'll just wait and see if anyone can point to speific inconsistences with my presentation of abct and garrisons (supported with some sort of textual evidence of course).
Which part of Garrison's lecture on ABCT (linked also in another recent thread), conflicts with Rothbard's or any other exposition on ABCT? Are you sure you are not simply mixing (confusing) between the no-credit-expansion (before 43:00 in the above link) and the credit-expansion (after 43:00) assumptions in all your ABCT sources?
Z.
Z,
I definately don't think I am confusing the no-credit-expansion v. credit expansion arguments.
Below you will find a modified version of what I've said before about what I think are the differences between Garrison and Rothbard. Hopefully that will clear things up. Link and quotes are provided to illustrate what I see as being conflicts (important points are bolded or underlined).
PS* Writing these posts and digging up these quotes is taking forever and no one seems to be reading them that closely (at least not krazy kaju or liberty student). I'm not saying anything in the post below I haven't already said previously in the thread (or last year as a matter of fact when I first called out the apparent differences). Not much I can do about it now I guess since I've already written it up. Just wanted to vocalize that this convo is getting tiring. I think the best thing to do is to let this sit for a day or two. That way, folks have an actual chance to read the articles and portions of the book being linked and decide for themselves. Feel free to PM me if you have questions.
--
Quick Summary of Differences Between Garrison and Rothbard
Basically the difference is that Garrison thinks investment and consumption rise together during the boom, Rothbard does not. This sounds like a small difference, but if you read critiques by Bryan Caplan and Paul Krugman you will find that there are significant problems with Rothbard's approach (two being 1) measured investment and consumption do seem to together during booms and fall together during busts and 2) rothbard's theory imples that consumption goods industries should thrive and that their prices should rise during recessions and we simply do not see that either).
For more detail see below.
----
Garrison's Theory
Garrison clearly believes that investment and consumption should rise in tandem during the boom phase. As he says in his 2004 article in the History of Political Economy, "Credit expansion increases both investment and consumption without there being any corresponding curtailment." http://www.auburn.edu/~garriro/strigl.htm
This is important for Garrison's theory because it is the fact that rising investment and consumption are pulling resources toward the early and late stages of production and away from the middle stages. As a result, existing capital goes under maintained and eventually can longer produce the same ammount as before:
Overconsumption and Forced Saving in the Mises-Hayek Theory of the Business Cycle (Garrison, 2004) The low interest rate that accompanies the boom phase of a credit expansion directs resources to the early stages of production. But at the same time, the increased demand for consumption goods is accompanied by an increased (derived) demand for resources in the very late stages. Resources are pulled in that direction, too. For a time both kinds of policy-induced misallocations can occur, as depicted as a double distortion of the Hayekian triangle. The misallocation of resources (both malinvestment and overconsumption) shown in Figure 2 corresponds to the economy that has reached the hollow diamond point along the adjustment path that extends beyond the PPF. The Hayekian triangle shows resources being allocated away from middle stages of production in both directions. This movement would translate into Strigl's account of the unsustainable boom as increased consumption and increased long-term capital creation, both made possible, in part, by the undermaintenance of existing capital.
Overconsumption and Forced Saving in the Mises-Hayek Theory of the Business Cycle (Garrison, 2004)
... Not far [into the boom phase] the limits imposed by scarcity become increasingly binding, but the low rate of interest continues to favor investment over consumption. At this point it does matter that the investment community gets the new money first. Resources continue to be bid into the early stages, while production processes that were in their middle stages at the beginning of the expansion—and from which resources were being misallocated at point 1—now begin to yield a declining volume of consumables. http://www.auburn.edu/~garriro/strigl.htm
Not far [into the boom phase] the limits imposed by scarcity become increasingly binding, but the low rate of interest continues to favor investment over consumption. At this point it does matter that the investment community gets the new money first. Resources continue to be bid into the early stages, while production processes that were in their middle stages at the beginning of the expansion—and from which resources were being misallocated at point 1—now begin to yield a declining volume of consumables. http://www.auburn.edu/~garriro/strigl.htm
Rothbard's Theory
By contrast, Rothbard does not see investment and consumption rising together. instead, investment rises first during the boom as new money first enters the loanable funds market (pushing down interest rates and encouraging investment in and it is only after "new money percolated downward" as income to the original factors of production that we see a rise in consumption. Indeed, in Rothbard's account, it is this increase in consumption that reveals to businesses that savings have no in fact increases (that time preferences have not changed) and that investing in more roundabout methods of production was a bad idea. Below you will find quotes from both MES and AGD demonstrating Rothbard's argument.
America's Great Depression (Rothbard): Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business?[6] The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in "longer processes of production," i.e., the capital structure is lengthened, especially in the "higher orders" most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers' goods, and this stimulates a shift of investment from the "lower" (near the consumer) to the "higher" orders of production (furthest from the consumer)—from consumer goods to capital goods industries.[7] If this were the effect of a genuine fall in time preferences and an increase in saving, all would be well and good, and the new lengthened structure of production could be indefinitely sustained. But this shift is the product of bank credit expansion. Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rents, interest. Now, unless time preferences have changed, and there is no reason to think that they have, people will rush to spend the higher incomes in the old consumption-investment proportions. In short, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. Capital goods industries will find that their investments have been in error: that what they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production have turned out to be wasteful, and the malinvestment must be liquidated. http://mises.org/rothbard/agd/chapter1.asp#boom_and_depression
America's Great Depression (Rothbard): Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business?[6] The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in "longer processes of production," i.e., the capital structure is lengthened, especially in the "higher orders" most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers' goods, and this stimulates a shift of investment from the "lower" (near the consumer) to the "higher" orders of production (furthest from the consumer)—from consumer goods to capital goods industries.[7]
If this were the effect of a genuine fall in time preferences and an increase in saving, all would be well and good, and the new lengthened structure of production could be indefinitely sustained. But this shift is the product of bank credit expansion. Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rents, interest. Now, unless time preferences have changed, and there is no reason to think that they have, people will rush to spend the higher incomes in the old consumption-investment proportions. In short, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. Capital goods industries will find that their investments have been in error: that what they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production have turned out to be wasteful, and the malinvestment must be liquidated. http://mises.org/rothbard/agd/chapter1.asp#boom_and_depression
Man, Economy, and State (Rothbard) First, the money supply increases through credit expansion; then businesses are tempted to malinvest—overinvesting in higher-stage and durable production processes. Next, the prices and incomes of original factors increase and consumption increases, and businesses realize that the higher-stage investments have been wasteful and unprofitable. The first stage is the chief landmark of the “boom”; the second stage—the discovery of the wasteful malinvestments—is the “crisis.” The depression is the next stage, during which malinvested businesses become bankrupt, and original factors must suddenly shift back to the lower stages of production. The liquidation of unsound businesses, the “idle capacity” of the malinvested plant, and the “frictional” unemployment of original factors that must suddenly and en masse shift to lower stages of production—these are the chief hallmarks of the depression stage.
Student:Basically the difference is that Garrison thinks investment and consumption rise together during the boom, Rothbard does not. This sounds like a small difference, but if you read critiques by Bryan Caplan and Paul Krugman you will find that there are significant problems with Rothbard's approach (two being 1) measured investment and consumption do seem to together during booms and fall together during busts and 2) rothbard's theory imples that consumption goods industries should thrive and that their prices should rise during recessions and we simply do not see that either).
The difference is irrelevant. Both Garrison and Rothbard are describing very similar and equally unsustainable distortions of the Hayekian triangle by credit expansion (interest rates manipulation). I don't see how one description precludes (conflicts with) the other. The difference between Garrison's and Rothbard's scenarios seems to be in the mechanisms for making the new credit available to consumers. Rothbard assumes that all (or most) of the new credit goes to business (investments) -- which has probably been the case through banking history -- whereas Garrison assumes that non-zero portions of it may also go to consumers (consumption), as it did during the latest housing boom when consumption was supported by using mortgage refinancings and home equity loans as ATMs by consumers. So in booms when new credit was not as easily or quickly available to consumers, less (none) of it would go to them and more (all) would go to business (investments), as described by Rothbard. In booms when the new credit is also easily available to consumers, more (some) of it would go to consumption and less (some) to investments. Where's the (allegedly, ABCT-busting) contradiction?
I don't see why ABCT's viability must rest on predicting a rigid distribution ratio of the new credit expansion between investments and consumption, as if every boom must resemble all others.
>> Now, unless time preferences have changed, and there is no reason to think that they have, people will rush to spend the higher incomes in >>the old consumption-investment proportions.
This is still the boom phase right? people rushing to spend their incomes in the same proportion of investment/consumption as when they had lower incomes means a that investment and consumption are rising in tandem? right?
your second Rothbard quote is maybe not his most eloquent moment but it does contain increased consumption on the boom-boom/crisis half of the business cycle and the 'depression' half comes after ....
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
The difference between Garrison's and Rothbard's scenarios seems to be in the mechanisms for making the new credit available to consumers.
No. that is incorrect. if you would kindly read the quote i provided (or even better the entire essay containing it) you would see that garrison is talking about an increase in consumer spending derived from a corresponding increase in worker income. The credit expansion still enters as new loans to businesses just like in Rothbard.
This really shouldn't be open for interpretation as Garrison makes this assumption explicit earlier in the same essay.
To allow for market forces that are pushing towards some point beyond the frontier during a credit expansion is to recognize that there will actually be some movement—some quantity adjustments—in that direction. New money is being lent to the business community and spent on investment projects. Closely on the heels of this effect, workers and other factor owners are earning greater incomes and spending them to a larger extent than before on consumption goods. In the early phase of the expansion, it doesn't much matter that it is the business community that gets the new money first. There is no significant lag between the earning and the spending. http://www.auburn.edu/~garriro/strigl.htm
And this isn't an irrelevant difference. This is a critical departure from Rothbard. In Garrison we see comovement of investment and consumption. In Rothbard, we don't. That is an essential difference in terms of how the business cycle operates and what patterns we expect to obeserve in the real world.
And again, I don't think I am the first to notice this. I think this is exactly the point Peter Boettke was making in a recent blog post.
Peter Boettke: Roger Garrison has tried to explain the possibility of comovement [between investment and consumption] due to the artificial nature of the boom which appears to violate the scarcity constraint...in the standard textbook presentation of the Mises-Hayek story we do not see comovement, but the distortion of the structure of production, which is then corrected during the bust phase. http://austrianeconomists.typepad.com/
Once we recognize that there are differences between Garrison and Rothbard, we have to ask which theory is better. But we simply can't get to that stage until we fully read and understand both arguments. So please take a look at Man, Economy, and State and Time & Money. Then we can potentially discuss more substantial issues. Until then...there's really nothing else to say.
Student:Writing these posts and digging up these quotes is taking forever and no one seems to be reading them that closely (at least not krazy kaju or liberty student).
I never read what you write closely.
This quote worries me ...I’ve seen yet of the Austrian view that’s sweeping the GOP I'm afraid that these type of labels will eventually serve to undermine our intelectuals. It would be better to remain a fringe movement without much publicity than to be labled some brand of "Republican-economics"--that is, unless the Republicans actually do start subscribing/implamenting such economics. I'm thinking our writers should do something quickly to distance ourself from the GOP. I can see it now, "Well, according to Mises" --"Mises...who cares about that right-wing crank...that Republican economist...etc."
That's already happened. Did you see a Joe Conason column in the New York Observer?
What is ironic is that von Mises saw himself as a "progressive" and sympathized with the 19th century German Progressive Party, and much like today's progressives, he complained about "reactionaries" and "conservatives" ruining plans for labour reform and democracy. Now, to be honest, I found von Mises a little immature when he complained about religion, about the Catholic Church, and about many elements of the old establishment, but it's that exact kind of immaturity I see in today's progressives. And now that Conason thinks von Mises and Bastiat were Republican Party style thinkers, I wonder if von Mises' own style has come to bite him back with him being labelled the reactionary and "right wing crank".
I think student has a point. And even if he doesn't; it's still interesting to think about the 2 different concepts of ABCT - even if they are wrongfully acquitted to Rothbard/Garrison.
But isn't it more interesting to debate which of the 2 theories is correct?
The state is not the enemy. The idea of the state is.
That would be pretty cool if that was the case.
I don't understand the supposed differences. There are no differences. In one consumption remains the same, in the other consumption rises. These are not that different from each other, and the way the pricing process works remains the same.
EDIT: This is exactly the reason why I thought Garrison's book was subpar. There is no explanation of the pricing process. Non-specific factors of production are pulled to later stages of production progressively. Imagine that there is an excess supply of fiduciary media, distributed though the loan market. Consumption good prices remain the same (or even rise a bit, due to an increase in consumption), most new investment will go to second-order goods. This increases the price of second-order goods, and therefore makes it more lucrative to invest in the third order goods, and non-specific factors of production get distributed in this fashion.
It's not as if non-specific factors of production immediately go to later stages. It requires this pricing process to give incentive to invest in earlier stages of production. If there is less expenditure on "middle stage" goods, then earlier stages will also progressively see less and less expenditure, given that there is no financial incentive to make these investments. The triangle lengthens to the degree that the profit margins between each stage narrows sufficiently.
Student:The credit expansion still enters as new loans to businesses just like in Rothbard.
Then, I hereby propose a "third" ABCT theory which teaches that the credit expansion can also enter via new loans made directly to consumers, like it happened in the latest boom. Please refute it -- with minimum appeals to authority, if possible.
Seriously, the best "attack" you can come up with is about ABCT's "inconsistency" in predicting (modeling) the exact distribution of the "easy money" between investments and consumption? People actually write ground-breaking economic research about this?
And this isn't an irrelevant difference.
OK.
z1235,
whoever said that was an attack????? have you even read this thread, *at all*? or did you decide to start posting assuming that you knew where the "battle lines" were drawn. jee wheez, man!
the only reason we are talking about rothbard v. garrison at this point is that krazy k started spouting off about abct thinking that rothbard's argument was the same as garrison's. they are not. and realizing that is important if you want to understand what predictions abct has for the real world. well, let me rephase. it is imporant if you care about economics. if you just care about citing any theory of the business cycle (that you may or may not understand) you think suits your political preferences then i guess all of this would sound irrelevant. "rothbard and garrison still both blame the credit expansion and the fed, right man? what else matters!"
gosh, dude. you're really harshing my zen thing. And I'm just going to say it. It's pretty surprising that I am one of the most well read austrians in this thread. or maybe not so surprising. i can see through lead too, if i really want to.
Student:whoever said that was an attack?????
Well if you are blowing up particular boom-specific artifacts into "relevant" (conflicting? inconsistent?) differences between the two ABCT expositions, then was I wrong to have sensed your implication that perhaps neither of them may be valid or correct? "Look folks, Garrison says ABCT explains this (60-40 easy money split between investment and consumption), Rothbard says ABCT explains that (100-0 split), while Krugman empirically measured something altogether different (50-50 split)!! Something fishy going on here. Not only is the empirics inconsistent with the theory but the theory seems to be inconsistent with itself!!"
Or, let's pretend you did not mean to attack anything. What would your reply have been had I not used the word?
There are 2 reasons why i think this is important.
1) explaining how recessions happen - both rothbard's and garrison's theories have different implications for why output falls during a recession. according to garrison's theory (as i understand it), output falls at the end of the bust because the economy simply can't produce as much as it did before. why? because a rise in investment in new capital and* spending on consumer goods led to the undermaintenance of existing capital. sure, there was new capital created, but in the wrong stages of production. so once the boom ends, production is much less...well, productive.
under rothbard's theory the mechanisms behind the recession are less clear. investment rises first as lower interest rates direct resources to earlier stages of produces. but, later, as the income of the original factors of production grows and this signals to businsesses that the investments they had made in more round about methods of production were unjustified. as a result, resources flow from producing capital goods to producing consumer alright, but shouldn't this story imply a boom in the consumer goods industry during recessions? if so, why do we have a recession at all? blamming market frictions isn't convincing because it wouldn't explain why there wasn't a recession when resources flowed from making consumer goods to making capital goods at the beginning of the boom. maybe there is some other argument you can make, but that is beside the point.
2) empirical verification - supposedly the abct was crafted to explain events we witness in the real world. specifically, the fluctuations in output and employment we call the business cycle. yet, one key feature we notice during business cycles is that investment and consumer spending seem to move together during "booms". and further, we don't see consumer spending rising relative to investment during recessions. these observations are in direct contradiction of rothbard's theroy. now, i'm sure you could argue "well hey, the economy is complex and maybe those aggregated statistics are hiding subtle movements underneath". but that is just arm chair theorizing unless one goes out and do some empirical work using more disaggregate data to back it up. so far, no evidence seems to support rothbard's predicitons. yet. garrison doesn't have that problem. his predictions (at least on these counts) seem to conform to the stylized facts of business cycles.
now, you can take or leave my opinions of which theory is actually the better of the two. but i hope this adequately demonstrates *why* this seemingly trivial difference is actually very important.
of course, again, it is only important if you care about the economics. if you're just looking for policy perscriptions, then i don't think there is much difference between the two. and i would say that's why some folks don't bother with the details.
I would have said..
OK. S.
S.