There is a discussion I am having with another individual on another forum. To avoid taking that thread off topic, I am moving the discussion to where more people could take part in defending the Austrian theory of the trade cycle (not sure if a proper refutation of Caplan has been written and is easily accessible). Let's start from page one. The argument is as follows:
Perhaps you could link me to what you consider to be a good refutation of some of the stuff he says about business cycles. Specifically, what I'm interested in is this
"Thus, it is readily conceded that (a) expansionary monetary policy reduces interest rates, and (b) lower interest rates stimulate investment in more round-about projects. Where then does the disagreement emerge? What I deny is that the artificially stimulated investments have any tendency to become malinvestments. Supposedly, since the central bank's inflation cannot continue indefinitely, it is eventually necessary to let interest rates rise back to the natural rate, which then reveals the underlying unprofitability of the artificially stimulated investments. The objection is simple: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account."
I'm not very interested in the utility curve stuff. The behavioral economics research is the only really interesting stuff I've ever read discussing utility curves.
Any links or responses would be good. I will link him to this thread. Hopefully he will join the forums.
shostak: According to a prominent critic of the ABCT, GordonTullock, One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.[1] Even von Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann he wrote, It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.[2] ----------- The question then is: how could correct expectations regarding the outcome of the loose monetary policy of the central bank prevent the boom-bust cycle? The job of businessmen is to stay on guard as far as consumers' demands are concerned. So whenever they observe a growing demand they react to this. For instance if a builder refuses to act on a growing demand for houses because he believes that this is on account of loose monetary policy of the central bank and cannot be sustainable, then he will be out of business very quickly. To be in the building business means that he must be in tune with the demand for housing. Likewise any other businessman in a given field will have to respond to changes in the demand in the area of his involvement if he wants to stay in this business.
According to a prominent critic of the ABCT, GordonTullock,
One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.[1]
Even von Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann he wrote,
It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.[2]
-----------
The question then is: how could correct expectations regarding the outcome of the loose monetary policy of the central bank prevent the boom-bust cycle? The job of businessmen is to stay on guard as far as consumers' demands are concerned. So whenever they observe a growing demand they react to this. For instance if a builder refuses to act on a growing demand for houses because he believes that this is on account of loose monetary policy of the central bank and cannot be sustainable, then he will be out of business very quickly. To be in the building business means that he must be in tune with the demand for housing. Likewise any other businessman in a given field will have to respond to changes in the demand in the area of his involvement if he wants to stay in this business.
http://mises.org/story/1131#_ftnref2
Salerno
http://mises.org/pdf/Salerno/chap6.PDF
Anthony J. Evans · Toby Baxendale
http://mises.org/journals/qjae/pdf/qjae11_2_1.pdf
there are lots of links in the bibliographies; plus lots more if you mises site search 'caplan cycle' or 'tullock cycle' ; havent tried 'rational expectations cycle' but likely a good bet too.
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Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account.
Hayek addresses this. If a businessman borrows at low interest rates, he does not care if the Federal Reserve raises them in the future; he will only owe money at the interest rate at which he first borrowed. A rise in interest rates does not make his organization less profitable; it makes it less profitable to begin new businesses or to get new loans for the existing businesses.
Organizations do not fail just because the Federal Reserve increases interest rates, or because they rise on their own. The businesses fail because the dearth of capital increases the costs of inputs for capital goods producers. The capital shortage happens as an effect of the fact that consumers have not decreased consumption, but instead have increased consumption of durable goods due to the low interest rates. Simultaneously, demand for labor-savings capital equipment drops as consumer goods producers shift from capital to labor-intensive orders of production. So, the capital goods producers get squeezed from falling demand and prices and rising prices of inputs.
If credit has been extended beyond the extent of voluntary saving, business costs end up being higher than predicted as businesses bid up the prices of unexpectedly scarce factors of production. These increased costs will necessitate more borrowing, this time at the higher interest rates.
This article, by Bill Anderson, also addresses this dilemma.
I can testify that the explainations cited by the previous posters are not just theoretical. I actually discussed the then impending mortage market collapse with several lenders from 2003 through 2007. They agreed that the mortgage conditions were unsustainable but maintained that they had to make their profits while they had the opportunity. Business people don't have the luxury of sitting in a white tower and contemplating the long-term effects of their actions. They have to profit or perish.
I'm the guy from the other forum.
This is where my opinion lies. This is what we mean when we talk about the efficient market hypothesis. We've come up with plenty of financial instruments just to hedge against interest rate risk. I don't deny that interest rate risk can make it harder for businessmen to make forecasts for their business, but I am not convinced that there is anything special about interest rate risk over any of the other myriad of risks that businesses face. Maybe back before we had large, liquid financial markets that was the case, but I just don't see how "unnatural" interest rates can be the main driver of the business cycle in 2009.
It's the main driver of any business cycle, really. You never know when the easy money will end, so you go for all you can get now. And if you have friends in the central bank who will bail your ass out--you get even more if you can.
what does interest rate risk has to do with it?
the interest rate is primarily driven by politics; with the economic causal laws flowing out from political decisions and coming into effect.
what sophisticated instruments do you have to hedge the risk of the government misallocating credit, and distorting the price signals which entrepeneurs must rely on to allocate between future and present goods.?
ask yourself what entrepeneurs could use to economise with respect to the future if the interest rate was somehow forbidden knowledge to them. imagine a mad scientist made a device, that whenever you thought of an 'interest rate' zapped your brain and disrupted your thought. would it be a) just as easy; b) no difference c) harder for entrepeneurs to plan the futures of their business.
you can think of the fed and the arms of government as frequent zappers; they don't allow the entrepreneurs to get as good a grip on what the natural rate is....
The short answer is, that it is not necessarily so that the central bank will raise interest rates. It may be that it maintains those rates until hyperinflation ensues. As long as the low interest rate policy is maintained, it is perfectly rational to invest in "malinvestments", as inflation will reduce the cost of borrowing to nothing.
Should businessmen refuse to borrow at low interest rates because they expect it to be only temporary, then the central bank can intervene deeper into the market by directly purchasing bonds on the open markets. This scenario is unfolding now.
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Only tangentially related, but you might find this interesting http://www.youtube.com/watch?v=2OQm-bCbvtY
Modern macro is unsatisfying, but that doesn't mean we have to go all the way over to the Austrian side.
This was my very first q in the forums. I read many excellent replies, and came up with one of my own that I later saw Peter Schiff assumes to be obvious. I also heard an apology that Mises wrote his version at an early age.
Here's my answer: If there is all that money available for free, people will be very hairbrained and foolish with it. They have no choice really. The free money out there draws them like a moth to a flame. Who can resist. But there is no where to spend it, at least no where smart. It takes years of careful planning to know what to do with a lot of money. So it's spent on wild ridiculous things, roads leading nowhere, cities in the middle of a desert, dotcom stocks that dont make anything, housing loans to people that cant possibly repay, as history seems to show over and over.
My private guess is that Mises probably could have dug this up with some research, but it would have made economics much less of a "science" like geometry, with every step a forgone conclusion from the earlier ones. After all, this one requires stating that people are irrational when they have oodles of easy money in their hands and nothing to do with the moolah. Easily verifiable with a bit of research, but sloppy. You mean people are stupid? And get stupider with easy money in their hands? I don't believe it, hahaha at your so called science.
Also there was his research that showed it's the heavy industry that goes bad usually in a boom, at least in his day.
Well that's my take, from a total newbie, but as I said, I've heard Peter Schiff assume it as obvious.
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Jonathan M. F. Catalán:What I deny is that the artificially stimulated investments have any tendency to become malinvestments.
That's all you need right there. Maybe he doesn't understand what the term 'malinvestments' means? Interest rates are the inter-temporal price mechanism which ration scarce resources, and puts them into the most capable hands. If you reduce this price, and stimulate investments, all of which cannot be completed either on time, at all, or at the expense of a more warranted economic activity, you have just created malinvestments, since inflation does not create any more real resources. The market actors who can profitably operate only in the face of perpetual and incremental doses of inflation (reduction of market rate of interest below natural rate) bid away resources from those who don't need inflation. Even if you know that the interest rate is artificially low (how they would know this, who knows?), you're still going to do what's profitable.
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Le Master: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account. Hayek addresses this. If a businessman borrows at low interest rates, he does not care if the Federal Reserve raises them in the future; he will only owe money at the interest rate at which he first borrowed. A rise in interest rates does not make his organization less profitable; it makes it less profitable to begin new businesses or to get new loans for the existing businesses. Organizations do not fail just because the Federal Reserve increases interest rates, or because they rise on their own. The businesses fail because the dearth of capital increases the costs of inputs for capital goods producers. The capital shortage happens as an effect of the fact that consumers have not decreased consumption, but instead have increased consumption of durable goods due to the low interest rates. Simultaneously, demand for labor-savings capital equipment drops as consumer goods producers shift from capital to labor-intensive orders of production. So, the capital goods producers get squeezed from falling demand and prices and rising prices of inputs. If credit has been extended beyond the extent of voluntary saving, business costs end up being higher than predicted as businesses bid up the prices of unexpectedly scarce factors of production. These increased costs will necessitate more borrowing, this time at the higher interest rates. This article, by Bill Anderson, also addresses this dilemma.
Thanks for the links, enjoyed your post.
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