Suppose we had the gold standard and every major bank held 100% of deposits in reserve.
Now, the only determinant of an economy's production structure would be real savings. What would happen then, if a majority of savers decided, for whatever reason, to decrease savings by a large portion. Wouldn't that drive up real interest rates and thereby eliminate many business projects, cause major short-term unemployment, secondary deflation and so on, in short, wouldn't that cause a typical Austrian Business Cycle?
If they are not saving they must be spending.
We are the soldiers for righteousnessAnd we are not sent here by the politicians you drink with - L. Dube, rip
I think if you asked Roger Garrison at Auburn Univ, he would answer no.
I think he would say that when the government increases the money supply and "artificially" reduces the interest rate you will have a situation where businesses want to invest more (specifically in early stages of production) and consumers want to consume more (which requires investments in late stage production). And that the only way to meet both of these demands is to some extent deplete the capital stock by letting it depreciate and go unreplinished (specifically capital in the "middle" stages of production). So when the "natural" interest rate reasserts itself you have a mismatch in the capital structure which must be corrected by liquidations and capital restructuring. This results in a recession for a variety of reasons, I think mainly because with capital in the middle stages of production depeleted, you cannot produce the amount you produced before the "boom". So you get a "bust".
Suppose savings increased naturally because consumers wanted to spend less. There would be no tension between early and late stage production, so you would not have an inter-temporal mismatch. People would be consuming less and resources would be moving from late stages of production to early stages.
The same goes for your example, if people decrease their savings, you would not have a inter-temporal mismatch and resources would move smoothly from producing investment goods to producing consumer goods.
See here for more detail:
http://www.auburn.edu/~garriro/a1abc.htm
Or something like that. But I really don't buy Austrian Business Cycle Theory. The entire thing, as presented by Garrison, rests on a very particular understanding of the "structure of production" and dividing it between early and late stages. This really doesn't make sense in the real world. How do we distinguish which capital goods are for early and late stage production? A truck can either carry bricks between construction sites or kids between soccer practice, where does it get filed? I am told all of this is beside the point and thoroughly explained in very big books, but I think it is beyond me.
Ambition is a dream with a V8 engine - Elvis Presley
Why would it create "secondary deflation"? The volume of money has not changed.
The Austrian business cycle is created by the economy becoming depleted of real wealth due to a central bank's inflationary money creation policy. Real wealth is depleted because consumers spending counterfeit money (creating loans out of thin air) are securing goods / wealth simultaneously as producers - who earn money by producing goods - try to consume. If producers saved their money and did not spend it, that money would be lent to the debtors instead of a printing press having to create it. Debtors would then consume the goods that the producing savers are deciding to consume in the future (when they are re-created by the debtors).
You are proposing a scenario where everyone's time preferences immediately changes. They prefer to consume today instead of in the future. I only see something like this realistically happening if there was an asteroid headed for earth and everyone knew it would wipe out all civilization. Such an event would misalign the time structure of current production with people's new time preference. But if that asteroid hits in 24 hours, why bother restructuring. You should instead be getting drunk, eating unhealthy and be getting busy with your wife/girlfriend/attractive stranger.
If you had a stable money supply (that was not inflated) then I would not expect a broad systemic "economic shocks" or credit bubble bust to create such an abrupt change in people's consumption time preference. On a local community scale you could have a localized problem because the circus came to town and restraunts invested in larger dining rooms, when they shouldn't have, creating a localized bust when the circus leaves... but I don't see why that would happen on a grand nation wide scale, without central bank monetary inflation being the cause.
If they're not saving it, what are they doing with it instead?
Yes there will be a recession if the decline in savings is a sharp one and is happening all at once, however, this "recession" would unfold differently from what we are use to with the typical bust that results from credit expansion.
A decrease in savings is a decrease in capital and a higher rate of interest. Capital will be consumed instead of being reinvested. The fall of savings is a rise in consumption. Higher order factors of production will be liquidated and owners of factors will have to sell their factors to lower order productive stages. This means that consumer retailers may actually experience a boom as a result while producers in the higher stages experience a slump.
This whole process indicates a sharp rise in timer preference. The economy is in the process of shrinking instead of expanding.
bearing01:Why would it create "secondary deflation"? The volume of money has not changed.
Secondary deflation, as Hayek used the term, isn't caused by central banks but by individuals fearing future economic hardships.
bearing01: I only see something like this realistically happening if there was an asteroid headed for earth and everyone knew it would wipe out all civilization.
The price for potatoes fluctuates as does the price for oil, gold and everything else. Why shouldn't the price for lending money fluctuate as well?
bbnet: If they are not saving they must be spending.
The problem with your argument is, that the whole economic system is structured according to prevailing interest rates. This means, if long-term interest rates have prevailed for a long time at 5%, there will be many companies that achieve returns of just above 5%. If, for some reason, interest rates rise to 10% or above, many companies are forced to shrink or will go bankrupt altogether.
I just don't see any reason why an interest rate-rise caused by the free market should have any different effects from a central bank induce business cycle.
@ Student: I think that Garrison's production triangle is incapable of explaining economic reality. It only shows the production process of consumer goods, but capital goods and their production processes are entirely omitted.
What's your definition of "deflation"?
When you have 100% reserve banking (a fixed money supply, as if it were commodity money) how does fear of future economic hardship or the price of lending money create deflation?
I don't consider a fluctuation in the purchasing power of money to be deflation or inflation.
If future economic hardships are expected, many people may decide to hold their savings in money as opposed to other assets like stocks (iow: people will hoard cash). This will depress economic activity and put downward pressure on prices.
If you don't want to call that deflation, that's fine. Labels are beside the point the op is trying to make. indeed, this is a point Hayek and other Austrians have been making since at least the 1930s. I think many Austrians have forgot about the concept of "secondary deflations" because, as Hayek noted, it opens up the possibility of positive government intervention.
Student: If future economic hardships are expected, many people may decide to hold their savings in money as opposed to other assets like stocks (iow: people will hoard cash). This will depress economic activity and put downward pressure on prices.
Marko: Silly. They will not hoard cash. They will put it in banks, from where it will be lent out.
Silly. They will not hoard cash. They will put it in banks, from where it will be lent out.
Yes.
Taking money out of a bank and putting it in a mattress (taking it out of circulation) is deflationary. Mattress money that never gets spent is dead money. Money horded in bank accounts never stays put. It gets lent out and someone else spends it.
Assuming people trust the banks to stay open.
But even if they do put their physical currency in banks instead of their mattresses, they will likely keep their money in liquid "demand accounts" (like the checking account at a bank)
Why does this matter? Because with "demand accounts" you can access your money at any time. This means banks cannot really rely on lending that money to anyone for extended periods of time. That's why you don't typically earn much interest on those accounts if any at all, banks don't want to pay you to keep your money sitting where they can barely use it (I actually have to pay a fee for my checking account. :( ). This is exactly why demand accounts are included in most definitions of the money supply.
Why would we assume that people keep their money in demand accounts? Because they expect hard economic times to be coming that will call upon them to have cash at hand. You can argue that this is unlikely to happen. But the point is that it is possible and it *could* happen. And if it did, it would a "deflationary" impact.
PS* Think of it this way. If I cash out my 12 month COD and put it into my checking account because I'm afraid I might need the money soon, then I am actually increasing the cash portion of my portfolio (and reducing the amount of money available for lending), even though the money has never left the bank.
Student: Why does this matter? Because with "demand accounts" you can access your money at any time. This means banks cannot really rely on lending that money to anyone for extended periods of time. That's why you don't typically earn much interest on those accounts if any at all.I actually have to pay a fee for my checking account. :(
Why does this matter? Because with "demand accounts" you can access your money at any time. This means banks cannot really rely on lending that money to anyone for extended periods of time. That's why you don't typically earn much interest on those accounts if any at all.I actually have to pay a fee for my checking account. :(
bearing01: Marko: Silly. They will not hoard cash. They will put it in banks, from where it will be lent out. Yes. Taking money out of a bank and putting it in a mattress (taking it out of circulation) is deflationary. Mattress money that never gets spent is dead money. Money horded in bank accounts never stays put. It gets lent out and someone else spends it.
You are completely misunderstanding the question at hand.
The questions was not about moving from one type of savings to another type of saving. It was about a decrease in savings, which is by definition, means a rise in time preference. This means a rise in consumption. If people are putting their money under the mattress, then their time preference has not risen at all, just their preference for one type of saving over another.
I was not referring to the question at hand, I was describing what a "secondary deflation" is, which at least one person asked.
Can a secondary deflation happen if people have a shift in time preference? I think so. They may be saving less money over all, but as a result of fears of coming recession, they may shift the balance of their portfolio toward cash.
"secondary deflation" is more about portfolio composition (what assets are you holding your savings in, i.e. cash/bonds/metals/stocks) than it is about time preference (the total amount you are saving).