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?
The increase in the supply of money raises growth expectations which automatically raises the price of investment goods. The price of consumption good, however, remains at the inital level. This is a change in relative prices meaning that resources will be drawn into the investment sector in the short run. This raises the demand for investment but since there has also been an increase in the supply of money, the supply curve also shifts to the right.
This occurs because the increase in the money supply has a disproprtionate effect on different prices in the short run. The example with shoes doesn't correspond at all.
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IrishLiberal:In his book "Age of Turbulence" Greenspan expresses the conflicts he had to resolve in being a libertarian AND a regulator.
I just spit out my coco puffs. What idiocy!
'Men do not change, they unmask themselves' - Germaine de Stael
Jake McCloskey: The increase in the supply of money raises growth expectations which automatically raises the price of investment goods.
The increase in the supply of money raises growth expectations which automatically raises the price of investment goods.
Where is the "automatic" raise in prices of investment goods now that the monetary base has been doubled? The above is total nonesense!
Jake McCloskey: The price of consumption good, however, remains at the inital level. This is a change in relative prices meaning that resources will be drawn into the investment sector in the short run. This raises the demand for investment but since there has also been an increase in the supply of money, the supply curve also shifts to the right.
The price of consumption good, however, remains at the inital level. This is a change in relative prices meaning that resources will be drawn into the investment sector in the short run. This raises the demand for investment but since there has also been an increase in the supply of money, the supply curve also shifts to the right.
The only way for the interest rate not to fall due to your hypotheical increase in supply is if the demand curve also shifts to the right so as to offset the supply curve shift to the right. But there is an infinite amount of causal elements that can be responsible for shifting the demand curve to the right, or left, or whatever. The curve is a mental construct anyway. It doesn't follow that an increase in money supply must somehow shift the curve to the right (or left). There is nothing that you can say about how and when it moves.
Jake McCloskey: The example with shoes doesn't correspond at all.
The example with shoes doesn't correspond at all.
The example is very appropriate. People don't suddely value shoes higher on their marginal value scale just because the supply was increased. If the supply of shoes is increased, then the demand for shoes also increases, but because the price was lowered! Not becasuse the demand curve shifted to the right. In the same way, people don't suddenly value credit more, just because more people save. The demand for credit is increased because the supply curve shifted to the right, the interest rate was lowered, the market was cleared.
You don't get that the demand curve is just the mental construct of the aggregate demand schedule of individuals. That schedule is at the heart of the subjective theory of value.
DD5:Where is the "automatic" raise in prices of investment goods now that the monetary base has been doubled?
The monetary base has doubled. This does not mean that the supply of money has doubled. Banks have not been lending most of it out because they are being paid by the Fed to keep it as reserves.
DD5:The only way for the interest rate not to fall due to your hypotheical increase in demand is if the demand curve also shifts to the right so as to offset the supply curve shift to the right.
THAT IS WHAT I AM SAYING. I said it many times. The demand curve shifts to the right along with the supply curve.
DD5:t doesn't follow that an increase in money supply must somehow shift the curve to the right (or left). There is nothing that you can say about how and when it moves.
Well then there is nothing you can say about how the supply of loanable funds shifts after an increase in the supply of money. All I am saying is that there are a number of different ways the interest rate could respond to an increase in the supply of money.
DD5: You don't get that the demand curve is just the mental construct of the aggregate demand schedule of individuals. That schedule is at the heart of the subjective theory of value.
You don't seem to get that nominal changes in the money supply can affect demand. I'm not talking about an increase in saving. I'm talking about a nominal increase in the money supply.
Jake McCloskey: 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 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.
No, it's the other way around.
http://en.wikipedia.org/wiki/Supply_and_demand
Quantity demanded refers to changes along the demand curve, while an increase or decrease in demand suggest a shift in the curve, not a movement along the curve.
Jonathan M. F. Catalán: Jake McCloskey: 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. No, it's the other way around. http://en.wikipedia.org/wiki/Supply_and_demand Quantity demanded refers to changes along the demand curve, while an increase or decrease in demand suggest a shift in the curve, not a movement along the curve.
I think it is more precise to say that it is a change in the demand schedule that shifts the curve. The actual demand for goods will always depend on the given supply. The price then changes for a given demand curve so as to clear the market.
Jake somehow sees a direct causal relationship between the demand curve itself and the supply. This is absurd! Why would people value something more just because it is more abundant?
I don't know what's more precise, but any textbook explicetly says that a change in demand is represented by a shift of the curve, while a change in quantity demanded is a movement along the curve. I was simply referring to his above post. A change in demand can come from several different options, including an increase in purchasing power, a change in aggregate taste, et cetera.
Jonathan M. F. Catalán:Quantity demanded refers to changes along the demand curve, while an increase or decrease in demand suggest a shift in the curve, not a movement along the curve.
You haven't been reading my comments. That is exactly what I said.
DD5:Jake somehow sees a direct causal relationship between the demand curve itself and the supply. This is absurd! Why would people value something more just because it is more abundant?
I never said there was a causal relationship between supply and demand. I said inflation affects both the supply and demand for loanable funds by affecting expectations. It is not the increase in the supply which triggers the increase in demand. The excess supply of money raises both. In the long run, neither should be affected.
Jake McCloskey: DD5:Jake somehow sees a direct causal relationship between the demand curve itself and the supply. This is absurd! Why would people value something more just because it is more abundant? I never said there was a causal relationship between supply and demand. I said inflation affects both the supply and demand for loanable funds by affecting expectations. It is not the increase in the supply which triggers the increase in demand. The excess supply of money raises both. In the long run, neither should be affected.
Your level of obfuscation over a simple supply & demand curve analysis is almost making me walk away from this. But perhaps this is a misunderstanding. I will give it one last try:
Your are not taking into consideration the temporal structure of production. This is the mistake of the mainstream economists. They are not familiar with he temporal structure of production so they are blind by the obvious. Once you take the temporal structure of production into account, and you start inserting time lags into your analysis between the supply, demand, and expectations, perhaps it will be more clear.
Perhaps the misunderstanding is that you are not making a distinction between the unrealistic money supply increase that is dropped from a helicopter, and the one that is injected through the banking system. The Austrian Business Cycle specifically blames the increase in credit as the means to increase the money supply. This causes a temporal distortion in the structure of production. It is precisely the fact that there is a time lag between the effect of the new money in the credit market and the consumers market that creates the misallocation of resources. When credit is first created, the money is first available in the loans market. Credit first has to be loaned out before prices begin to rise. At the current price levels, interest rate must drop in order to induce more investment.
I'm going to explain this from the beginning.
In an ideal world where prices adjust perfectly to increases in the money supply, the supply of loanable funds would not be changed by an increase in the money supply, cetereic paribus. Neither would the demand for loanable funds. We do not live an ideal world. CERTAIN prices take time to adjust while others don't. The prices of auction-syle assets (bonds, stocks, etc.) change immediately to changes in the supply of money. Standard consumer goods prices don't respond immediately.
Say the Fed increases the supply of money. The asymmetry in price sensitivity between different goods creates a change in relative prices between investment goods and consumption goods. Investment goods are now more valuable compared to investment goods. The demand for loanable funds increases. In other words, the demand curve for loanable funds shifts to the right. At the same time, the supply of loanable funds increases because of the failure of some prices to respond to the increase in the money supply. In other words, the supply curve of loanable funds shifts to the right. BOTH CURVES SHIFT. The change in the interest rate depends on which curve shifts more.
Time enters the picture in the form of the different rates at which consumer and investment good prices change in response to the money supply increase. Investment good prices respond immediately while consumer good prices can take a year or more to fully adjust. It doesn't matter how the new money enters the system. There is no distortion if the increase in the money supply occurs during an offsetting increase in the demand for money. Resources used to produce comsumer goods become unempoyed after the increase in the demand for money but are then reemployed in the production of investment goods after the money supply increase. This is exactly what would happen in the ideal world I mentioned where prices adjust perfectly, only the nominal increase in the money supply wouldn't be necessary.
Also, don't patronize me by saying the "mainstream" economists don't take this or that into consideration. I was introduced to economics through the Mises Institute and I attended the 2008 Mises University. I even participated in the Mundliche Prufung. I've read Garrison's book, I've read Human Action, I've read countless Mises Institute articles. I currently attend Mario Rizzo's Austrian colloquium at NYU. However, as I've read and talked to more mainstream economists, I've realized they take a lot more of the Austrian insights into account than the Mises Institute economists think or care to admit.
I still think Greenspan was trying to play out a D'anconia fantasy through the Fed.