http://www.slate.com/articles/business/the_dismal_science/1998/12/the_hangover_theory.html
We've seen it before, but even when I first read it I knew that it at least seemed facile or glib. Krugman's criticism was, as Murphy explained and as even I suspected, easily countered by saying that an investment boom and a consumption boom are simulataneously possible, just as the destruction of one industry and the rise of another need not imply a depression in one and a boom in the other.
So, is there some hidden genius to his criticism that I'm not seeing?
That article is very interesting.
Imagine a Martian who has no concept of happiness, only of food. He reads a poem about someone being happy. Since the Martian doesn't know what happiness is, never having felt it or any other emotion, the best he can do, after listening to various explanations, is to conclude that "I am happy" means "I have plenty of food in stock."
He then reads a story that says "I opened the fridge this morning and saw I had no food left, but I didn't care. I was happy."
The Martian sees a contradiction. You just said you had no food, and then you say you are happy, meaning you have plenty of food. What gives?
Krugman in the article is like that Martian. His explication of Austrian theory is riddled with mistakes and misunderstandings, all stemming from his "translating" what Austrians say into what the Keynesians are used to thinking about.
I'm inspired to write an article laying it all out. Will post here if/when it's finished.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
First half posted.
https://smilingdavesblog.wordpress.com/2013/03/21/flaws-in-krugmans-hangover-theory-in-simple-language-part-one/
"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)."
False. Expansion of the monetary base and expansion of the money supply through fractional reserve lending are instances of income obtained without someone spending.
"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"
No, it doesn't mean that. They can also abstain from spending, i.e. save.
Fakename,
As I have said before, I think people give Krugman undeserved shit on this article. When Murphy was explaining that investment and consumption rise together, he was basically repeating Roger Garrison's account of the ABCT. But this is not the only version of ABCT floating around out there. It is certainly not the one Rothbard used.
If you read America's Great Depression or Man, Economy, and State, you will see that Rothbard does not see investment and consumption rising together. Instead, he argued that investment rises first during the boom as new money first enters the loanable funds market (pushing down interest rates and encouraging investment) 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.
This is VERY important. If consumption and investment do not rise together there is really no reason to believe that capital in the middle stages of the capital structure will deteriorate, which is critical to Garrison's and Murphy's story about why the economy cannot produce as much during the "recession" phase of the business cycle.
So Rothbard's account doesn't explain at all why a dip in investment doesn't necc lead to an increase in consumption (and thus no recession). In other words, Krugman's criticism is 100% valid for Rothbard's account of ABCT. But you never see Murphy (or anyone else mention that). Instead, they pull a switch-aroo and pretends that Garrison's word on ABCT has been and always been gospel.
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.
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.
Ambition is a dream with a V8 engine - Elvis Presley
Garrison... Rothbard...an increase in consumption (and thus no recession).
Too bad Krugman later retracted his hangover theory criticism:
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.
Of course, he thinks he has found other problems, but here he has confessed that the problem that he thought in his hangover theory article annihilates ABCT is invalid.
The thing is, in the hangover theory article, he was assuming, like Student seems to be doing, that the problem that causes recessions is always and only lack of aggregate demand. So hey, if the demand shifts from investment to consumption, we're fine. No recession. As long as the bottom line aggregate of demand, meaning spending by anyone for any reason on anything, is out there somewhere, there cannot be a recession. That's why he thinks he has outwitted the Austrians in that hangover theory article. They have not succeeded in explaining why there is less spending. In fact, according to Austrians, Krugman thinks, there must be an equal amount of spending always no matter what happens, given Keynes' [mistaken] understanding of what Say's Law says, and given that Austrians accept Say's Law.
After reading the article by Bob Murphy that somebody sent him, Krugman's eyes were opened. He grasped that lack of aggregate demand is not the only cause of a recession. Which is a radical departure from Keynes, and which is why Krugman has a hard time accepting it as true in the real world. But he does finally get that it's possible in theory to have other causes. In particular, wasting of precious resources on a massive scale [what Krugman calls "degradation of the country’s underlying productive capacity"] can also induce a recession, at least in theory. Which is really what ABCT has been saying all along. Looking around for what the aggregate demand is doing is barking up the wrong tree, according to Austrians. They are trying to explain why there has been massive wasting of resources. And Rothbard's version explains that quite nicely.
Bottom line: Keynes: Only cause of recession is lack of AD. Austrians believe, though they don't know they believe it, that lack of AD is impossible. Thus they believe, though they don't know they believe it, that recession is impossible. In other words, those dumbos have not thought things through.
Austrians: There are many causes for a recession. In particular, massive wastage of resources is one of them. Lack of AD is not one of them, even if it happens. In theory there may be a lack of AD due to hoarding, although in the real world this has never happened. But it doesn't really matter, because lack of AD never causes recessions, ever.
Perhaps someone can make a Venn diagram of this. The title will be "What Causes Recessions?" On the left side there will be a circle labeled What Keynes Thought Causes Recessions, and inside the circle will be the words "Lack of Aggregate Demand." On the right side will be a circle labeled What Austrians and Classical Economists Though Causes Recessions. It will have two entires inside it. One will be "Massive Wastage of Precious Resources". Another will be "Other Things".
The two circles will not intersect.
I don't see anything about a retraction in that blog post. I just see Krugman responding to Bob Murphy's explainaiton of ABCT (which as I said before is closest to Roger Garrison's exposition). Nothing in that post negates what he said in the hangover article, which still applies to Rothbard's conception of ABCT.
Also, I'm not saying that the only way recessions can happen is by drops in aggregate demand. And I have never said that. All I said was that *Rothbard's* theory actually doesn't explain recessions at all for the reasons Krugman and others provides.
I think the problem is that you are assuming there is only one version of the ABCT. This is not true. And that really shouldn't disturb anyone. There is no such thing as "the" Keynesian Business Cycle Theory either.
Also, Smiling Dave, do you ever get the feeling like you are doing the econ equilivance of a club comedy act?
"Keyenesian economists dial the phone like this: beep beep beep boop"
"Austrian economists dial the phone like this: beepty beep boop bob"
I don't see anything about a retraction in that blog post.
Did you even read it?
I just see Krugman responding to Bob Murphy's explainaiton of ABCT (which as I said before is closest to Roger Garrison's exposition).
Did you even read my post?
Also, I'm not saying that the only way recessions can happen is by drops in aggregate demand. And I have never said that.
What other ways do you know about? What way are Garrison and Murphy claiming is the cause? What way is Rothbard claiming is the cause?
All I said was that *Rothbard's* theory actually doesn't explain recessions at all for the reasons Krugman and others provides.
I think the problem is that you are assuming there is only one version of the ABCT.
I think the problem is you are getting hung up on irrelevant details. All Austrians agree on the essence of the ABCT.
Student: Also, Smiling Dave, do you ever get the feeling like you are doing the econ equilivance of a club comedy act? "Keyenesian economists dial the phone like this: beep beep beep boop" "Austrian economists dial the phone like this: beepty beep boop bob"
Your comment reminded me of this feller.
http://www.cbsnews.com/8301-504083_162-57355226-504083/beezow-doo-doo-zopittybop-bop-bop-arrested/
Also, Smiling Dave, do you ever get the feeling like you are doing the econ equilivance of a club comedy act? "Keyenesian economists dial the phone like this: beep beep beep boop" "Austrian economists dial the phone like this: beepty beep boop bob"
You would do well to address the ideas, not waste everyones time with ad hominems.
Yes. Please point me to the place where he says "therefore my original post on hangover theory was wrong". He doesn't say that because it isn't true. His original post holds true, just not for the version of ABCT that Bob Murphy was using.
Did you even read *my* post before you started going into boiler plate about Keynesians v. Austrians? I explained Rothbard's theory then provided relevant quotes. I thought you already understood Garrison's theory, but if you need me to explain that too, I can.
Yes, but most of it makes no sense. Since you go off about "Student must mean..." and then say some stuff about aggregate demand then Say's Law. It makes no sense as it doesn't relate to what I originally said, so I thought I would just repeat my main point in hopes of avoiding debating your strawmen. I mean, do you honestly think Krugman had no clue recessions could be caused by anything other than AD? Come on.
I think the problem is you are getting hung up on irrelevant details. All Austrians agree on the essence of the ABCT
If you think the differences between Garrison and Rothbard are irrelevant details, then you don't understand ABCT. Whether consumption and investment rise simultaneously or not MATTERS as I already explained above.
shackleford,
lol. nice. i told my lady the story and first thing she guessed was "arrested on drug charges?"
PS* Is your name a reference to randy shackleford? Alias of Dale Gribble?
Student: shackleford, lol. nice. i told my lady the story and first thing she guessed was "arrested on drug charges?" PS* Is your name a reference to randy shackleford? Alias of Dale Gribble?
It's Rusty Shackleford. It's the name I order pizza with. LOL.
Please point me to the place where he says "therefore my original post on hangover theory was wrong".
I'm sorry I cannot teach you reading comprehension. But I will lay it out as best I can. Murphy wrote an article refuting Krugman's hangover theory article. Krugman grasped, what you apparently don't, that the gist of Murphy's rebuttal is that the boom degrades the country's prodcutive capacity. He does not go on to say "Murphy missed the boat. He thought he rebutted me, but he didn't." Instead he writes that he likes what Murphy wrote, and that it indeed may happen at times.
If you think that Murphy's explanation of degradation of the country's prodictive capacity depends on Garrison's exposition, and is incompatinble with Rothbard's please show us exactly why that is so.
I explained Rothbard's theory then provided relevant quotes.
Thos quotes do not answer my simple question. What is the cause of the recession according to Rothbard? Is it lack of AD? Is it degradation of the country's productive capacity? Is it something else? Same questions for Garrison. No need to explain the whole theory according to him. Just answer the above easy, simple, short questions.
I think your explanation is erroneous, no offense. The error stems from what I have been trying to get you to grasp using the Socratic method, mainly what is the heart of ABCT? Krugman finally got it. Which means you now have permission to as well.
Sadly, I think we are once again hitting that wall that for some reason precludes our understanding each other.