Most Austrians are quick to blame Greenspan for the 2008 financial crisis. The criticism stems from Greenspan's perceived mishandling of interest rates in the years after the dot-com bust. Greenspan, it seems, suppressed interest rates and sparked a credit expansion and subsequent purging consistent with a classic Austrian Business Cycle.
In his book "Age of Turbulence" Greenspan expresses the conflicts he had to resolve in being a libertarian AND a regulator. He had to work within the parameters of his remit, otherwise his reign at the FED would have been quite short. Greenspan is of the view that the continuing effects of globalisation are the principal reason for the global downward pressure on interest rates. Competion from Asia is having a disinflationary effect in the developed world. Interest rates therefore had to be low to prevent possible deflation.
Due to the absence of a "free-market in money" the setting of interest rates is largely arbitrary and subject to whim. I feel that Greenspan is being unfairly impugned as of late. Where am I mistaken?
Jonathan M. F. Catalán:Low interest rates, according to the ABCT, were the main reason for the bubble (well, inflation, or an increase in the supply of money was the key factor).
Interest rates play no role. They are a red herring. The ABCT says that an increase in the supply of money in excess of the demand for it will lead to malinvestment equal in quantity to the credit generated by the short run increase in the real money supply. Whether or not the recent housng bubble was caused or influenced by this mechanism is an empirical question. Show me your evidence.
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Jake McCloskey: Interest rates play no role. They are a red herring. The ABCT says that an increase in the supply of money in excess of the demand for it will lead to malinvestment equal in quantity to the credit generated by the short run increase in the real money supply. Whether or not the recent housng bubble was caused or influenced by this mechanism is an empirical question. Show me your evidence.
The ABCT suggests that an increase in the money supply will cause a decrease in lending interest rates (because there is a greater supply of money). Low interest rates catalyze investment, because businessmen see it as profitable to borrow and invest, and thus widen and lengthen their stages of production. And so, interest rates play a key role in the Austrian Business Cycle Theory (see: Jesús Huerta de Soto, Money, Bank Credit and the Business Cycle and Friedrich Hayek, Prices & Production).
Jake McCloskey: The ABCT says that an increase in the supply of money in excess of the demand for it will lead to malinvestment equal in quantity to the credit generated by the short run increase in the real money supply.
The ABCT says that an increase in the supply of money in excess of the demand for it will lead to malinvestment equal in quantity to the credit generated by the short run increase in the real money supply.
Why do I have a feeling you've been reading White, Selgin, or Horowitz? These guys confuse everybody (including themselves) with their equilibrium theories. Any dollar added to investments MUST be met by a dollar decrease in consumption!! That is what they all mean by investments come from real savings. If there are more dollars channeled into investments then there are savings (by the process of credit expansion), those extra dollars will cause misallocation of resources. Interest rates are artificially lowered. Isn't it obvious that when you have more supply of money to lend because of credit expansion, you will have a lower interest then if the only the real savings were loaned out?
Why do I have a feeling you've been reading White, Selgin, or Horowitz? These guys confuse everybody (including themselves) with their equilibrium theories.
Any dollar added to investments MUST be met by a dollar decrease in consumption!! That is what they all mean by investments come from real savings.
If there are more dollars channeled into investments then there are savings (by the process of credit expansion), those extra dollars will cause misallocation of resources. Interest rates are artificially lowered. Isn't it obvious that when you have more supply of money to lend because of credit expansion, you will have a lower interest then if the only the real savings were loaned out?
I using Mises' version of the theory. Hayek used interest rates because Keynes used interest rates. They are really not central to the theory.
Jonathan M. F. Catalán:The ABCT suggests that an increase in the money supply will cause a decrease in lending interest rates
This isn't necessarily true. Increases in the supply of money can potentialy lead to higher interest rates. In fact, most long-term rates increase after an increase in the money supply.
DD5: Isn't it obvious that when you have more supply of money to lend because of credit expansion, you will have a lower interest then if the only the real savings were loaned out?
No. The interest rate may increase because of a much increased rate of growth. Also, many rates will immediately incorporate inflation expectations.
In The Theory of Money and Credit, by Mises, interest rates do play a cetral role in his business cycle theory. He explicitely states (p. 404, Liberty Fund version) that a crisis can be adverted if banks decrease interest rates on loans (which require an increase in the supply of money). He finishes Chapter 19 with:
The the catastrophe occurs, and its consequences are the worse and the reaction against the bull tendency of the market the stronger, the longer the period during which the rate of interest on loans has been below the natural rate of interest and the greater the extent to which roundabout processes of production that are not justified by the state of the capital market have been adopted.
In fact, Chapter 19 deals explicitely with the effect of interest rates on the stages of production.
Jake McCloskey: No. The interest rate may increase because of a much increased rate of growth.
No. The interest rate may increase because of a much increased rate of growth.
You have to elaborate on this one. It sounds a little Keynesian.
Jake McCloskey: [Also, many rates will immediately incorporate inflation expectations.
[Also, many rates will immediately incorporate inflation expectations.
If the consequential factors on interest such as inflation would be greater then that of the actual money supply increase, then no credit expansion would take place. Let me put in another way: If the bank is to be fully loaned up (no excess reserves), which is usually the case during a boom, then interest rates must have been lower then the "natural" rate, that is if you expect the aw of supply and demand to still hold.
If banks do not lower interest rates below the natural rate, because they are cautious (as they are now!), then banks maintain excess reserves as they do now. But what is this debate about? I thought it was about when credit expansion does take place, not when it doesn't. When it doesn't there is no boom anyway.
@ Jonathan Catalan:
He may have used interest rates as the transmission mechanism, but this was because he was working within a Wicksellian natural rate framework. Interest rates are not at the core of the theory.
@DD5:
If we are in a recession, increasing the supply of money can lead to growth expectations which can cause the rate to rise.
The natural rate refers to the intersection of desired investment and desired saving. Banks could have no reserves and still be at the natural rate.
This debate was oringinally about whether the Austrian theory always holds. I think it has an effect but it isn't entireley responsible for the current crises.
Jake McCloskey: @ Jonathan Catalan: He may have used interest rates as the transmission mechanism, but this was because he was working within a Wicksellian natural rate framework. Interest rates are not at the core of the theory.
No, they are. You are making half-hearted excuses to eliminate interest rates from the theory. You said you are taking Mises' theory, as opposed to Hayek's, but when presented with Mises' theory you have nothing to say other than "he was working within a Wicksellian natural rate framework".
Many theories can be based off multiple transmission mechanisms. Does that make these mechanisms "the heart of the theory?" I say it doesn't. I'm not a historian of economic thought so maybe Mises really, really thought interest rates were the culprit. It doesn't matter to me. As far as I can tell, interest rates are a bad indicator. An increase in the supply of money can lead to both an increase in credit and in increase in demand for investment. This would leave the interest rate at its initial level but there would still be malinvestment.
Jake McCloskey: If we are in a recession, increasing the supply of money can lead to growth expectations which can cause the rate to rise.
Elaborate! Not rewrite the same thing. I suspect you are attacking the problem with a Keynesian framework. You are confusing money growth and real growth. Elaborate!
Jake McCloskey: The natural rate refers to the intersection of desired investment and desired saving.
The natural rate refers to the intersection of desired investment and desired saving.
The natural rate refers to real demand and real supply. My desire to save does not add anything to the supply of savings until I actually save. Real savings means real goods that have been already produced are not consumed by the saver, but instead are channeled to higher order production stages for investment.
Jake McCloskey: An increase in the supply of money can lead to both an increase in credit and in increase in demand for investment. This would leave the interest rate at its initial level but there would still be malinvestment.
An increase in the supply of money can lead to both an increase in credit and in increase in demand for investment. This would leave the interest rate at its initial level but there would still be malinvestment.
The irony is that your avatar is a supply & demand curve.
What happends to the price when you shift the supply curve to the right? Look at your avatar!
Of course, the demand is increased. Because the price was lowered!
Increased growth expectations can lead to increased demand for investment. This will cause the demand for loanable funds to shift to the right, raising interest rates. Increased nominal growth can lead to increased real growth; I'm not confusing anything here and its not Keynesian.
Desired saving means ex ante saving. The best example I can give you is in the paradox of thrift. In the paradox, desired saving increases but real saving stays the same. The natural rate falls but the market rate stays the same. This is what I mean by natural rate.
DD5: The irony is that your avatar is a supply & demand curve. What happends to the price when you shift the supply curve to the right? Look at your avatar! Of course, the demand is increased. Because the price was lowered!
The demand for something is the curve itself. If the supply curve shifts right there will be an increase in the quantity demanded, not an increase in demand.
Jake McCloskey: Increased growth expectations can lead to increased demand for investment. This will cause the demand for loanable funds to shift to the right, raising interest rates. Increased nominal growth can lead to increased real growth; I'm not confusing anything here and its not Keynesian.
You are confusing the actual market demand and the demand curve.
According to your logic, when shoes are increased in supply (supply curve shifts to the right), the demand curve may shift to the right also to offset any lowering in price. Does this sound logical to you? The demand curve is determined by the subjective valuations of the consumers. This subjective valuation is not subject to our economic analysis. What we can say is that for a given demand curve, when the supply curve shifts to the right, the price must be lowered for the market to clear.
Jake McCloskey: DD5: The irony is that your avatar is a supply & demand curve. What happends to the price when you shift the supply curve to the right? Look at your avatar! Of course, the demand is increased. Because the price was lowered! The demand for something is the curve itself. If the supply curve shifts right there will be an increase in the quantity demanded, not an increase in demand.
The irony still holds!