Reading todays article, I saw the austrian business cycle theory presented, and now I understand why there is unemployment, and the business corrections that need to take place. So, because of this, do businesses really neglect some of their capital goods to go on the "sugar high"? If so, why don't you hear about this neglect of the crucial factor of production? How does pumping in money generate this (I am still confused, as the analogy of the sushi still does not convince me). It also sheds some light that government cannot fix this by diverting wealth.
Schools are labour camps.
The best explanation you can find are the relevant chapters in de Soto's Money, Bank Credit, and Economic Cycles, which you can find on this website.
In a nutshell, the business cycle can be explained like this:
The central bank injects new money into the banking system. This new money lowers the real and nominal interest rates below the level they would be at if the supply of loanable funds came out of people's own desire to save. In essence, we have "forced saving."
Private businesses see the lower interest rates and decide to invest more in capital goods. This creates a huge increase in productivity per worker. However, since the time preferences haven't changed for those workers, they still consume as much as they would before. This causes a "disequilibrium" in the capital structure (you might have seen this in Hayek's triangle) as the newly created money goes toward consumption, not saving/investment.
One result is inflation, since the consumption businesses compete with the capital goods businesses for natural resources, capital goods, workers, etc. Inflation can make it harder for businesses funded by these new low interest loans to survive without borrowing more to make up for inflation. The result is an increase in the demand for loanable funds. Corresponding, however, is a reduction in the supply as people begin to pull money out of banks due to real interest rates becoming lower and lower due to the rising inflation.
As the price of capital goods begin to rise and inflation accelerates, "lower order" businesses begin to use more labor instead of capital. Besides the fact that capital goods prices rise disproportionately, the real wages of workers fall as inflation eats up any nominal increases. This is obviously an incentive for businesses to hire more labor and less capital.
The result is that land, labor, and capital are bidded away from the "higher order" businesses, which are forced to liquidate and fail. This causes rising unemployment and falling stock prices that eventually hurt the "lower order" businesses due to falling sales.
That's pretty much the bare bone basics.
Political Atheists Blog
krazy kaju: In a nutshell, the business cycle can be explained like this: The central bank injects new money into the banking system. This new money lowers the real and nominal interest rates below the level they would be at if the supply of loanable funds came out of people's own desire to save. In essence, we have "forced saving." Private businesses see the lower interest rates and decide to invest more in capital goods. This creates a huge increase in productivity per worker. However, since the time preferences haven't changed for those workers, they still consume as much as they would before. This causes a "disequilibrium" in the capital structure (you might have seen this in Hayek's triangle) as the newly created money goes toward consumption, not saving/investment. One result is inflation, since the consumption businesses compete with the capital goods businesses for natural resources, capital goods, workers, etc. Inflation can make it harder for businesses funded by these new low interest loans to survive without borrowing more to make up for inflation. The result is an increase in the demand for loanable funds. Corresponding, however, is a reduction in the supply as people begin to pull money out of banks due to real interest rates becoming lower and lower due to the rising inflation. As the price of capital goods begin to rise and inflation accelerates, "lower order" businesses begin to use more labor instead of capital. Besides the fact that capital goods prices rise disproportionately, the real wages of workers fall as inflation eats up any nominal increases. This is obviously an incentive for businesses to hire more labor and less capital. The result is that land, labor, and capital are bidded away from the "higher order" businesses, which are forced to liquidate and fail. This causes rising unemployment and falling stock prices that eventually hurt the "lower order" businesses due to falling sales. That's pretty much the bare bone basics.
So if I got this right, the business cycle is caused by putting too much into increasing the number stages of production, and not enough into the lower, more original stages. What prevents individual firms from doing this, and how does the inflation cause this "trap"?
eliotn: So if I got this right, the business cycle is caused by putting too much into increasing the number stages of production, and not enough into the lower, more original stages. What prevents individual firms from doing this, and how does the inflation cause this "trap"?
What happens is that the lower interest rate pushes demand up for higher order goods, since more people can now afford to purchase these higher order goods (price goes down, demand goes up). This makes higher order goods-producing industries much more profitable, and thus entrepreneurs have incentives to expand their operations in that section of the economy. Likewise, these higher order goods allow production to be expanded, since most are capital goods.
However, inflation ensues, and several things happen. First of all, since inflation is not entirely predictable, numerous entrepreneurs might not have enough cash and might need more to finish the projects they started as to cover the basic costs of labor, etc. This pushes up the demand for loanable funds. Second, businesses closer to consumers (the "lower order" ones) get more profits since people consume more than they invest - and thus these businesses get more money via the stock market and what not, and these funds are diverted from the higher order businesses. Third, inflation creates a smaller incentive to save and invest since real (inflation adjusted) interest rates fall, thus driving away people from putting their banks. Fourth, higher inflation means that real wages begin to fall, creating an incentive for businesses to hire labor instead of capital (think about it in terms of time preference).
The combined result of less loanable funds, higher demand for loanable funds, a rising demand for labor, and a faster rise in lower order profits, forces some "higher order" projects to be liquidated as they can no longer obtain credit to cover costs. This obviously leaves some workers temporarily unemployed until the market can correct itself.