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Critique by Caplan on ABCT: Why dont consumption goods enjoy a boom during depressions?

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NicolasAugust posted on Sat, Mar 3 2012 4:43 AM

In my previous post you guys brilliantly answered on why Caplan et al. were wrong in their rebuttal of ABCT regarding their claim of rational expectations.

Now, another critique which I found it hard to find any material upon (the Mises Wiki does not really answer on this matter either) the objection made by Caplan: "why don’t the consumption goods industries enjoy a huge boom during depressions? After all, if the prices of the capital goods factors are too high, are not the prices of the consumption goods factors too low?”.

Thank you in advance

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My good ole blog handles this one:

http://smilingdavesblog.blogspot.com/2011/07/krugman-and-hangover-theory.html

Sure, it's about Krugman, but he has the same argument as Caplan, to wit:

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?

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Consumption goods industries may not experience a boom during a recession, because of the high level of debt. People consume less, and save more.

 
See also Huerta de Soto (p. 402, footnote 5).
Mark Skousen correctly indicates that, in relative terms, stagflation is a universal phenomenon, considering that in all recessions the price of consumer goods climbs more (or falls less) in relative terms than the price of the factors of production. Widespread growth in the nominal prices of consumer goods during a phase of recession first took place in the depression of the 1970s, and later in the recession of the 1990s. It sprang from the fact that the credit expansion which fed both processes was great enough in the different stages of the cycle to create and maintain expectations of inflation in the market of consumer goods and services even during the deepest stages of the depression (apart from the typical recent phenomena of relentless growth in public spending and in the deficit, and of massive social transfer payments which foster direct growth in the demand for, and therefore, in the prices of consumer goods and services). See Skousen, The Structure of Production, pp. 313–15.
footnote 21 (p. 420-421):
Mark Skousen, in his (already cited) article presented before the general meeting of the Mont Pèlerin Society of September 25–30, 1994 in Cannes, showed that in the United States over the preceding fifteen years the price of the goods furthest from consumption had oscillated between a +30 percent increase and a –10 percent decrease, depending on the year and the stage of the cycle; while the price of products from the intermediate stages had fluctuated between +14 percent and –1 percent, depending on the particular stage in the cycle, and the price of consumer goods vacillated between +10 percent and –2 percent, depending on the particular stage.
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SD, your blog post was fantastic. However, it seems you covered mostly the unemployment side of things, and not the supposed recession-time consumption boom.

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TY Wheylous.

Actually Krugman answered that one himself, as I mentioned in the blog [all bold font is just copied from the blog]:

He knows the answer to this one, and indeed spells it out in the next paragraph:

The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods.

Of course, it's not vague in the least.

Put another way,

Austrians say that a boom and bust cycle always begins by new money being pumped into the economy...

When the investment sector gets some of that new money, no money has been taken away from the consumer sector. The consumer sector keeps what money it has, so it doesn't have to fire anyone. The investment sector then uses its new money to lure away workers from the consumer sector with Help Wanted ads. That's why there is a boom, with no one getting fired. People just move from one job right into the next one.

The bust happens when, for reasons Austrian Economics explains, the investment sector wastes the new money on losing propositions. AE explains why this is inevitable...

...when the investors realize they have blown the money and there is no profit to be made in what they are doing, the firings start.

...When the time comes for the bust, the money has been wasted. There is no more money.

And thus no money for a boom in anything, neither investment nor consumer goods.

Bottom line, the unemployment side and the lack of a boom are two sides of the same coin. The reason there is unemployment is the same reason there is no boom, in fact one could argue that they are jsut two aspects of the same thing, a bust. Both are because money and resources have been frittered away, so of course how can you expect a boom in anything?

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Thank you for the answers.

Can you please elaborate on the point about the lack of a boom in consumption goods during a crisis? It seems to me that there must exist a profitable difference in the relative prices in this sector due to the overinvestment in capitalintensive industries and hence we might expect a boom in consumption goods during depressions?

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you cannot have a boom without money to fuel it. where is the money coming from? a depression means, by definition, the sad results of mass wasting of money.

put another way, you need previous underconsumption to increase the pool of resources. who underconsumed?

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Answered (Not Verified) Esuric replied on Sun, Mar 4 2012 10:02 PM
Suggested by ThreeTrees

The price of consumer goods should in fact rise relative to the price of producer goods at the very onset of the recession (it's what triggers the correction) and should continue throughout the correction. This doesn't mean that one should expect a "boom" in the consumer goods indsutries. In fact, the price of both may, and often do, fall in absolute terms. Additionally, a rise in the price of consumer goods only means a rise in the revenue for firms operating within the lower phases of production. 

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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So, now we have one person saying that no increase appears in consumer goods relative to capital goods and one person saying that it does happen and even adds that this is the very reason why the correction triggers?

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So, now we have one person saying that no increase appears in consumer goods relative to capital goods and one person saying that it does happen and even adds that this is the very reason why the correction triggers?

We have to define the terms. Price inflation= things cost more, which deSoto [quoted by Rodolphe earlier] said happens.

A boom means something else.

Here's a definition from wordiq.com: During booms, there is a high level of aggregate demand, inflation decreases, unemployment falls, and growth in national income accelerates.

From businessdictionary.com: A boom is characterized by an economy working at full or near-full capacity, strong consumer demand, low rate of unemployment, and a rising stockmarket, usually accompanied by rapidly increasing consumer prices (inflation). [Note that this website thinks inflation accompanies a boom, unlike the previous one].

None of that happens during a recession to consumer goods. I explained why earlier.

Bottom line, we are all saying the same thing.

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Thanks to NA for asking and all great answers! I've expanded the Mises Wiki to include these points.

@NicolasAugust: have you come across other, more or less common criticisms of the ABCT?

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I have indeed met a lot of criticism.

1. (1.a) Entrepreneurs must be said to expect the changes in monetary policy: Central Banks follow at least some rules guiding the monetary policy. So, critics maintain that companies, eg. Google, are not getting fooled by the lowered interest rates. If the Central Bank are making the inflation expected by entrepreneurs, no problem should arise. (1.b) They might add to this that it might be possible for the particular entrepreneur to forecast the prices relevant for him in his industry.

2. Critics reject the notion that entrepreneurs are "forced" to act foolish during a boom due to reckless entrepreneurs taking the cheap credit. Why are those entrepreneurs not being kicked out of the market (profit/loss mechanism). They add that more expensive production factors increase the cost of operating companies thus reducing production and the level of malinvestments. And again, they reject that entrepreneurs should be willing to take unnessecary risk just because reckless competitors do it.

3. Entrepreneurs are taking the interest as exogenous thus it does not matter what the natural rate of interest is. They thus reject that malinvestment should be carried out - for the particular entrepreneur the investment still seems profitable. For instance they might point to the present low interest rates and ask why entrepreneurs are not fooled by these right now? We are not seeing huge investments in capital goods now?

4, Finally, modern macroeconomists are not content with the empirical research made by Austrian economists. They are demanding econometric analysis showing that ABCT is showing empirically cusality.

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Okay, 1. and 2. should be sufficiently covered. 2. in particular forgets about the role of time - it can take years for a given phase of the business cycle to manifest, so by the time the rational businessmen are done ignoring the cheap money, they might as well be out of business; the more expensive production factors also tend to appear later in the cycle. Plus all the other arguments.

 

3. Not quite sure if I understand the "exogenous" part well - does it mean the entrepreneurs are simply ignoring the interest rate; or refrain from investing? Either case seems unlikely.

The second part is more interesting: currently, we are not in the boom phase, but in the bust phase, with everyone being careful with their spending and investment decisions (not to mention the amount of wrecked capital still lying around). So, businesses are less eager to invest and banks are less eager to borrow the money - the interest rate may be low but few are investing anyway. (Sources and additions welcome!)

 

4. Austrians do have their reservations about empirical research, but the following resources may be what you are looking for:

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Is there any coherent theory of ABCT, which takes rational expectations and consumption booms to account in theory and not after theory(unlike Rothbards one in Man, Economy and State), when people answer to the critiques? I heard Garrisons Time and Money is something new and Huerta de Sotos too.

-- --- English I not so well sorry I will. I'm not native speaker.
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"They add that more expensive production factors increase the cost of operating companies thus reducing production and the level of malinvestments."

 
In the words of Hayek, in "Money and Capital : A Reply" :
Every individual entrepreneur can increase his real capital only by spending more on capital goods and less on labour used in current production (or, what amounts to the same thing, more on labour which is invested for a relatively long period). He can, however, spend more on capital goods than on wages only so long as wages have not risen in proportion to the additional money which has become available for investment. Ultimately, incomes must rise in that proportion, since even the money used for the purchase of new capital goods must ultimately be paid out to the factors which make these new capital goods. But they will rise to the full extent only when all the new money has passed backwards through the successive stages of production until it is finally paid out to the factors. There will, therefore, always be a considerable ‘lag’ between the increase in the money used for productive purposes and the corresponding increase in the incomes of the factors – and consequent increase in the demand for consumers’ goods. And, so long as money keeps on increasing [...] the demand for producers’ goods will be increased relative to the demand for consumers’ goods.
Kel Kelly also dedicated a good post on this issue ("What Drives Profits?") :
But money and credit do in fact have a tremendous affect on nominal profits: as the money supply is increased, profits increase because revenues rise faster than costs. [...] the monetary value of revenues is usually greater than the monetary value of corresponding costs, since most costs were incurred when there was less money existing [...] Thus, credit expansion increases the spread between revenues and costs, thereby increasing profit margins.
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