Hi everyone,
One way of splitting up the business cycle debate into two sides is as follows: those who believe in the general glut theory of the boom, and those who believe that the boom is actually a relative distortion of some sectors to others. From what I understand, the Austrians are the latter. However, I am having trouble understand how it is that GDP can expand if some industries are booming at the expense of a commensurate number of others receding. Yes I know GDP has its faults.
In the modern economy, when credit expansion occurs, it provides funds for both consumers who spend it on lower order goods, and investors who, supposedly, invest in higher order goods. But surely when they see the demand for consumer goods increase, entrepreneurs will begin investing in factor inputs of a lower order too, causing demand for higher order goods, and so on. Will this not cause a general glut?
Any explanations and/or articles on the matter would be very helpful, thanks!
Fred
I think if you follow some links through google on "cluster of errors" you might find what you're looking for. http://www.google.ca/search?client=opera&rls=en&q=hayek+cluster+of+errors&sourceid=opera&ie=utf-8&oe=utf-8
I think Hayek won the nobel prize for actually describing the process of the boom-bust cycle.
You recognize that the lower interest rates will drive more investment in the higher-order stages of production. What this does is that it makes industries profitable for a period of time. Once market forces reign in and overcome the effects of the reduced interest rate, there is a sharp downturn in these "over expanded" sectors. The supply of credit tightens up, and these industries are no longer profitable.
The higher-order levels of production sell/move products to lower levels, but they are much more interest rate sensitive than the lower levels of production. The interest rate is the difference between an industry being profitable or not at the highest stages of production. That isn't quite the case for people buying things from the lower stages of production.
Giant_Joe: I think if you follow some links through google on "cluster of errors" you might find what you're looking for. http://www.google.ca/search?client=opera&rls=en&q=hayek+cluster+of+errors&sourceid=opera&ie=utf-8&oe=utf-8
I will do, thanks.
Giant_Joe: You recognize that the lower interest rates will drive more investment in the higher-order stages of production. What this does is that it makes industries profitable for a period of time. Once market forces reign in and overcome the effects of the reduced interest rate, there is a sharp downturn in these "over expanded" sectors. The supply of credit tightens up, and these industries are no longer profitable. The higher-order levels of production sell/move products to lower levels, but they are much more interest rate sensitive than the lower levels of production. I understand all of this. Including why higher order goods will be invested in more than lower order goods. However, is it not true that investment increases across the board (though more in some sectors than others)? Giant_Joe: The interest rate is the difference between an industry being profitable or not at the highest stages of production. That isn't quite the case for people buying things from the lower stages of production.
I understand all of this. Including why higher order goods will be invested in more than lower order goods. However, is it not true that investment increases across the board (though more in some sectors than others)?
Giant_Joe: The interest rate is the difference between an industry being profitable or not at the highest stages of production. That isn't quite the case for people buying things from the lower stages of production.
Well, if the demand for a good goes up, so will the price it commands, and hence profit will also rise, inducing firms to expand production of lower order goods.
My issue is whether investment expand throughout the entire economy or not. Or is it that despite an increase throughout the economy, the relative magnitudes of the higher and lower order goods still change, and that is what causes an imbalance?
I guess you are talking about the savings glut theory.
Mainstream economists can't see the whole picture............so they call the accumulation of credit funds a savings glut.
In economic we sometimes forget that things take time to happen. 200 billion dollars newly created today will defenetly cause princes to increase but it might take a month, a year ( i dont know) to happen.
Austrian on the other hand, accurately saw the bubble building up. When new money is created and accumulated it takes the form of "deposits" for both banking and accounting standards. However this is just money created out of thing air.
The problem is not how and what the so called glut develops. It begins by "credit expansion" as you well know. Eventually this money will disrupt, change, miss guide investors & consumers on what to do.
I am sure you will find everything you need in this ARTICLE
Corporatism is using state means to enhance market share and profitability of a few favored firms, at the expense of the citizen.
Fred Furash: Giant_Joe: The interest rate is the difference between an industry being profitable or not at the highest stages of production. That isn't quite the case for people buying things from the lower stages of production. Well, if the demand for a good goes up, so will the price it commands, and hence profit will also rise, inducing firms to expand production of lower order goods.
I think you might be confusing some things here.
Focusing on the highest levels of production:
The first thing that happens is that the interest rate goes lower, and that makes the capital for the higher levels of production cheaper. So for example, there would be more demand for mining equipment for a mining operation because it is easier to finance that equipment. Because of the cheap credit, mines that would otherwise be unprofitable (and not desired by the market) would become profitable. This continues until the supply of credit tightens. At this point, mines fail, the producers of the capital for mines fail.
Lower stages of production:
These are industries which are more focused on distributing/selling to consumers, and although use of capital exists here, it is not as much in the other stages of production, so there is little change here from the interest rate. So the interest rate does not directly affect these parts of production as much as the higher parts, but it affects the consumer's willingness to spend. The growth in these lower levels of production is a result of increased consumer demand enabled by lower interest rates.
However, is it not true that investment increases across the board (though more in some sectors than others)?
Investment increases happen most in the higher order stages of production and less in others as a result of a reduced interest rate. Increased investment in the lower order stages of production are mostly a result of increased demand by consumers which drive up prices and make these parts of industry more profitable.
This part I'm not completely sure about. All that comes to mind is Mises analogy of a builder building a house, thinking he has more bricks to build with than he really does, and gets a house about 80% done and realizes he's out of bricks.
The reduced interest rates bring more money into the system. Money that doesn't represent any "saved" good that hasn't been consumed. I think this is what causes people and producers to buy more and consume more and not save as much. I'm guessing it's this lack of "slack" goods that somehow causes imbalances and precipitates a sharp decline in an industry.
There's also some slides outlining this stuff, but I think I'm about as confused as you are some some specifics of how this all happens.
http://www.auburn.edu/~garriro/ppsus.htm
Giant_Joe: Focusing on the highest levels of production: The first thing that happens is that the interest rate goes lower, and that makes the capital for the higher levels of production cheaper. So for example, there would be more demand for mining equipment for a mining operation because it is easier to finance that equipment. Because of the cheap credit, mines that would otherwise be unprofitable (and not desired by the market) would become profitable. This continues until the supply of credit tightens. At this point, mines fail, the producers of the capital for mines fail. Lower stages of production: These are industries which are more focused on distributing/selling to consumers, and although use of capital exists here, it is not as much in the other stages of production, so there is little change here from the interest rate. So the interest rate does not directly affect these parts of production as much as the higher parts, but it affects the consumer's willingness to spend. The growth in these lower levels of production is a result of increased consumer demand enabled by lower interest rates.
So we agree that expansion occurs throughout the entire economy?
I guess we can say that there is both a general expansion of investment and consumption activity, and that this expansion is imbalanced within itself. I wish I could remember what article I was reading that was talking about this.
Fred Furash: So we agree that expansion occurs throughout the entire economy?
I could agree, but I don't know if it's right. :p I'm not saying I disagree. I'm just saying I'm not sure. I have to mention that it can be hard to qualify and quantify what exactly expansion is.
There might be some "middle stages of production" that don't grow. Or other parts of the economy that can't get capital or labor because it's being re-directed to somewhere else. When using aggregate measures like GDP and private investment, you can see the whole economy growing in during the boom. But expansion in some areas might be bigger than contractions in other areas during this boom, which leads to a higher aggregate total. (This is why the whole output gap thing is silly. It treats capital as being homogeneous.)
Lo and behold, I have found the article: http://mises.org/journals/qjae/pdf/qjae12_2_4.pdf
This is the article I had read that began my doubts. I just can't see how it is that the economy does not actually grow in a boom. I always thought that it did, just unsustainably so.