Economics Questions

Re: What's the counter argument?

Daniel James Sanchez — Sun, 10 Jan 2010 20:24:00 GMT

Smiling Dave:
"For instance, if investments rise, coeteris paribus, consumption must fall.

This betrays the common misconception that ABCT is about overinvestment. It's not. It's about malinvestment. It's about investment shifting into unfeasible lines of production, not about the total amount of that is invested at present increasing. When the structure of production is extended, it is not present investments that rise, it is the commitments for future investment that rise: commitments for which there aren't physically enough resources to fulfill. It is perfectly possible to increase consumption and increase investment commitments at the same time, just as it is perfectly possible for an individual to go on a shopping spree and start laying the simple groundwork for a factory he can't afford to finish building on the same day.

Re: What's the counter argument?

chloe732 — Sun, 10 Jan 2010 20:03:15 GMT

Smiling Dave:
Say you have a full refrigerator, stocked to bursting, shared by a few room mates. The deal is that everyone who takes something has to replace it within a week. Everybody does that but for one guy who takes out two at a time but gives back one. It takes a while for it to empty

I'll keep this analogy in mind, it appears to be a simple, yet accurate, explanation of the effect of money / credit expansion. There seems to be prosperity during the "boom" (the time when the guy is taking two items but replacing only one). Obviously, this "structure of production" can't be sustained. The boom during money / credit expansion is caused by capital consumption, like the dairy farmer who cuts meat off his cows. It seems like "boom times" to him because he is eating steak every night. When the last cow is consumed, there is no more milk, and no more production of real goods. The farmer's living standard declines. The bust.

Re: What's the counter argument?

Smiling Dave — Sun, 10 Jan 2010 12:37:18 GMT

More critiques.

I got this from http://www.coordinationproblem.org/2009/12/the-monetary-theory-of-the-trade-cycle.html?cid=6a00d83451eb0069e20120a73d0003970b#comment-6a00d83451eb0069e20120a73d0003970b

which scineram linked to earlier.

"Well, if ABCT is summarized as the theory which says that money injected in credit markets create too many investments that later need to be liquidated, everything is easy and intuitively appealling, as it is a good fit with the day-to-day experience. This is the newspaper version of ABCT.

"However, it is not a conspiracy of keynesian economists if this account doesn't hold water at a more careful scrutiny.

"For instance, if investments rise, coeteris paribus, consumption must fall. This is a point which everybody does against ABCT (Krugman, Cowen...). The logic is that if production is constrained, than the choice between investment and consumption is mutually exclusive, and thus the BOOM should be characterized by a FALL in consumer well being. This doesn't make any sense: the newspaper version of ABCT doesn't account for the most obvious of the observations."

Isn't the answer to this one that the bust is indeed the fall in consumer well being?

Maybe the question is: why does the fall in consumer well being not happen at the very same time as the boom in malinvestments? I think the simple answer is becuase it takes a while for the lack of stuff to be felt.

Say you have a full refrigerator, stocked to bursting, shared by a few room mates. The deal is that everyone who takes something has to replace it within a week. Everybody does that but for one guy who takes out two at a time but gives back one. It takes a while for it to empty

Re: What's the counter argument?

scineram — Sun, 10 Jan 2010 11:11:50 GMT

What about Cowen, Risk and Business Cycles? I have seen it referenced a lot.

Re: What's the counter argument?

Jonathan M. F. Catalán — Sun, 10 Jan 2010 03:57:37 GMT

I posted Piero Sraffa's critique here, and Hayek's response. A better critique of Sraffa is presented as the introduction to the book Contra Cambridge and Keynes, which explains why Sraffa so badly misinterpreted Prices & Production (and, if you read Prices & Production you realize how easy it is to misinterpret the book, unless you re-read it or at least read it very carefully).

Re: What's the counter argument?

Smiling Dave — Sun, 10 Jan 2010 03:34:27 GMT

Leviathan:

The earliest substantial criticism that I'm aware of comes from Nicholas Kaldor, who wrote Capital Intensity and the Trade Cycle, to be followed by Professor Hayek and the Concertina-Effect. Kaldor also alleged a shift in Hayek's views that caused an irreconcilable conflict between his writings, though Hayek denied it. There was also more limited criticism in a 1932 paper of Sraffa's, Dr. Hayek on Money and Capital.

I leave it to the wealthier posters who can afford to read those things at $43 a pop, to reply.

There's also some interesting content in Polanyi-Levitt and Mendell's The Origins of Market Fetishism - critique of Friedrich Hayek's economic theory.

This one seems to be the usual name calling [Markert Fetishism in the title says it all]. The claim is that all the Austrians loved Marx and loved the State until one bad apple came along, Mises. Mises' unfortunate run ins with the state made him a madman who hated the state irrationally. That's the origin of all his economic theories.

Is there also some economics in that paper? Not in the first few pages. I didn't read the rest. So maybe the ABCT has been trounced and rebutted somewhere in there.

Joan Robinson has given us a graphic account of Hayek's visit to Cambridge in 1931, where he covered a blackboard with his famous triangles. It appeared that he was arguing that the slump was caused by excessive consumption, which reduces the stock of capital goods. What looks like an oversupply of capital and a lack of demand for consumer goods is in reality too high a demand for consumer goods and an insufficient supply of capital. (Rosner, 1988) R.F. Kahn, who was at that time working on his explanation of how the multiplier equates savings with investment, asked Hayek the following question: "Is it your view that if I went out tomorrow and bought a new overcoat that would increase unemployment?" "Yes," said Hayek, "but," pointing to his triangles on the board, "it would take a very long mathematical argument to explain why."

We can see how reliable this charming anecdote is from its summary of ABCT.

There are also some problems with the ABCT's misguided focuses, as noted in Cwik's Austrian Business Cycle Theory: A Corporate Finance Point of View

The Austrian business cycle theory (ABCT) has been criticized for not being a true theory of the business cycle. The main emphasis of the ABCT has been on the theory of the upper-turning point—the artificial expansion of credit, the manipulation of interest rates, the malinvestments committed by entrepreneurs and then the credit crunch and/or real resource crunch.

Ahem. Somebody missed the boat here, and really badly. Cwik is saying that ABCT explains how busts happen, and the preventive medicine that will prevent them. As for what to do when someone bungles and creates a bust, how to get of the bust, all ABCT says is "get out of the way and let the market clean up its own mess."

Cwik says that although all of the above is 100% correct, there are idiots out there who have their own quick fix of how to get out. And ABCT hasn't spent enough time explaining in detail why the idiots are wrong, which is the topic of his paper.

That's what Mr Leviathan calls ABCT's misguided focuses.

If anything, the Austrian school should focus on developing a coherent theory of the firm and recovering from their loss in the socialist calculation debate to abandon their marginality, but I don't see it happening...

TY for your concern. BTW we won the calculation debate.

Re: What's the counter argument?

fakename — Sun, 10 Jan 2010 02:47:02 GMT

What I believe krugman is saying is that if money isn't being spent in one way it is being used in another. But I also think that robert murphy aptly attacks this view because to assume it is true, one could also prove that the death of a significant part of the population would never lower aggregate income.

Re: What's the counter argument?

Leviathan — Sun, 10 Jan 2010 02:17:44 GMT

The earliest substantial criticism that I'm aware of comes from Nicholas Kaldor, who wrote Capital Intensity and the Trade Cycle, to be followed by Professor Hayek and the Concertina-Effect. Kaldor also alleged a shift in Hayek's views that caused an irreconcilable conflict between his writings, though Hayek denied it. There was also more limited criticism in a 1932 paper of Sraffa's, Dr. Hayek on Money and Capital. There's also some interesting content in Polanyi-Levitt and Mendell's The Origins of Market Fetishism - critique of Friedrich Hayek's economic theory.

Joan Robinson has given us a graphic account of Hayek's visit to Cambridge in 1931, where he covered a blackboard with his famous triangles. It appeared that he was arguing that the slump was caused by excessive consumption, which reduces the stock of capital goods. What looks like an oversupply of capital and a lack of demand for consumer goods is in reality too high a demand for consumer goods and an insufficient supply of capital. (Rosner, 1988) R.F. Kahn, who was at that time working on his explanation of how the multiplier equates savings with investment, asked Hayek the following question: "Is it your view that if I went out tomorrow and bought a new overcoat that would increase unemployment?" "Yes," said Hayek, "but," pointing to his triangles on the board, "it would take a very long mathematical argument to explain why."

There are also some problems with the ABCT's misguided focuses, as noted in Cwik's Austrian Business Cycle Theory: A Corporate Finance Point of View

The Austrian business cycle theory (ABCT) has been criticized for not being a true theory of the business cycle. The main emphasis of the ABCT has been on the theory of the upper-turning point—the artificial expansion of credit, the manipulation of interest rates, the malinvestments committed by entrepreneurs and then the credit crunch and/or real resource crunch.

If anything, the Austrian school should focus on developing a coherent theory of the firm and recovering from their loss in the socialist calculation debate to abandon their marginality, but I don't see it happening...

Re: What's the counter argument?

Smiling Dave — Sun, 10 Jan 2010 01:54:08 GMT

fakename:

I think that (forgive me if you already know this, but I don't know that you know this) he means that in any macroeconomy spending and income can be represented by the simple accounting equation that spending from personA=income from personB. So if investment spends (or doesn't) then this money=income (or loss of income) in consumption.

But krugman 1) doesn't notice that his own critique forgets that when economies change they usually don't experience net unemployment and 2) that changes in the economy are done by actors and actions through time so that everything looks "hunky-dorry" one moment and then when everyone realizes there isn't enough real goods the depression begins.

LOL, you are closest to the truth if you assume I know very little.

Less spending from Person A on investment goods = Less income to seller B of investment goods. How does it follow from this that there is more spending on consumption?

Here's his original quote once again:

Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom?

What I don't get is how does the first sentence imply the second.

Re: What's the counter argument?

fakename — Sun, 10 Jan 2010 01:33:53 GMT

Smiling Dave:

He is talking about when the crash happens, I assume. Since the money isn't going into investing, it should be going into consumption. So there should a huge increase in jobs selling hot dogs and such. So there will be no unemployment. [I'm not sure how his simple arithmetic is relevant here.]

I think that (forgive me if you already know this, but I don't know that you know this) he means that in any macroeconomy spending and income can be represented by the simple accounting equation that spending from personA=income from personB. So if investment spends (or doesn't) then this money=income (or loss of income) in consumption.

But krugman 1) doesn't notice that his own critique forgets that when economies change they usually don't experience net unemployment and 2) that changes in the economy are done by actors and actions through time so that everything looks "hunky-dorry" one moment and then when everyone realizes there isn't enough real goods the depression begins.

Re: What's the counter argument?

Smiling Dave — Sun, 10 Jan 2010 01:21:42 GMT

fakename:

But don't forget krugman's response:

Because all income is someone else's income therefore if there was a glut in investment wouldn't we see a depression in consumer's goods and vice versa?

But this argument is by itself, a little flawed too.

here's a quote from Krugman that I found on http://www.slate.com/id/9593

He is talking about when the crash happens, I assume. Since the money isn't going into investing, it should be going into consumption. So there should a huge increase in jobs selling hot dogs and such. So there will be no unemployment. [I'm not sure how his simple arithmetic is relevant here.]

This is foolish, it seems to me. Don't look at paper money flying around, look at what there is to buy with it. I can decide to spend more on consumption, but what if there is nothing to consume? In the boom, all the factories made widgets. They used up the resources needed to make hot dogs [land building materials, workers] to make widget factories. Now there are no hot dogs to sell. That's what the recession is about, people losing money selling their unbuilt widget factories so someone can build a hot dog factory.

And if so why should there be a rise in unemployment? Because where will the money come from to hire workers to build the hot dog factory, and in fact to buy the land etc for it? Everyone just took a bath building widget factories.

Here are some more quotes from there:

But let's ask a seemingly silly question: Why should the ups and downs of investment demand lead to ups and downs in the economy as a whole? Don't say that it's obvious—although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them.

If people invest more money in a project, they hire workers and buy all kinds of things to build their project. So people have jobs. And when investors go broke, they fire people. It's not that complicated, really.

The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave "part of the work of depression undone," since mass unemployment was part of the process of "adapting the structure of production.") But in that case, why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment?

Huh? I'm about to build a new factory. I hire people to build it. This generates mass unemployment?

And anyway, this story bears little resemblance to what actually happens in a recession, when every industry—not just the investment sector—normally contracts.

What story? The ABCT says that when huge numbers of people get fired from their jobs [doing what was a waste of time] they don't have money to spend. So of course every industry will contract.

As is so often the case in economics (or for that matter in any intellectual endeavor), the explanation of how recessions can happen, though arrived at only after an epic intellectual journey, turns out to be extremely simple. A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory.

Which is like saying if I assume 2+2=5, it makes junk of the theory that 2+2=4. Yes, I agree.

Re: What's the counter argument?

Smiling Dave — Sun, 10 Jan 2010 00:35:00 GMT

About the Keynesian drone response:

Where did they get all this?

Just as an exercise, let's see what I can do with it.

The interest rate is only the return to financial assets in the bond market and has nothing to do with any real economic phenomena.

Wait a minute, don't you say later on that "interest rates should be low at all times in order to facilitate investment"? Doesn't that mean that the real economic phenomenon of investment is influenced by the interest rate? Yes it does.

Also, are you telling me that my decision to put my money in a bank or look for something else to do with it doesn't depend on the interest rate the bank is offering me? Then you are mistaken. And guess what? I highly doubt I am the only one.

And you are telling me that banks can up the interest rate on housing loans to say 20% a year and the same number of people will keep borrowing money to buy a home as when it's, say, a half a percent? This is the great Keynesian wisdom here?

Furthermore, there are many different interest rates for many different assets, and are funneled through many different channels. To speak of "one interest rate" is to speak nonsense.

Wait a minute, then you just spoke nonsense in your very first sentence. Let me quote you. "The interest rate is only bla bla bla."

And you are saying all these rates are unrelated right? A bank may lend to people at say 5%, and then give their depositors some totally unrelated number, say 19%, right? Or they will borrow from the Fed at a higher rate than they charge? I don't think so. Some interest rates influence others, don't you think? So there is some relation between them, and we can concentrate on the one that influences the others.

The interest rate doesn't equilibrate the market, as savings only equals investment after the fact through necessary business adjustments;

Hiding behind obscurity, hey? Tell me what this means in simple language, and we'll talk about it.

it's more accurate to say that savings is truly a function of income.

Of course a pauper with nothing to save will not save, so of course savings is a function of income. But we are beyond high school math now. Welcome to the real world, where a thing can be a function of many variables. And you are telling me that given the same income, if the bank tells me "I'll give you 20%," [like in Reagan's days] or if it tells me "I'll give you 1%" [like now] I'll save the same amount of money in the bank? What are you smoking?

Additionally, interest rates should be low at all times in order to facilitate investment,

Talk about a whopper. It depends where the money is coming from.

If it's coming out of a printing press then indeed giving it away for free to an investor will increase investments. But doing that will cause horrible inflation, see Zimbabwe and the Weimar republic. Or maybe you think that's good.

If it is coming from pre-existing money, that means someone has to be convinced to put their money in the bank in order for the bank to have money to lend to an investor. And the lower the interest he is getting for putting his money in the bank, the quicker he will run to put it there. Uh huh.

but regulations must be installed

And which all wise regulator will decide what regulations to install? Or maybe any idiot can do it.

so that liquidity isn't used solely for destructive and destabilizing speculation.

So the regulator is gonna say "Mr Banker, you are allowed to lend money to an investor, not to a speculator."

And the banker will ask "How can I tell who's who?"

"Simple, my child. If he is going to make money on his investment, he is an investor. If not, he's a destructive and destabilizing speculator."

"Good thing you regulated me, otherwise I would have been tempted to lend my money to someone I knew would throw it away. By the way, how can I tell in advance who will make money and who will lose?"

"That's your job, I'm just here to regulate you."

Business cycles are bound with capitalism and all of its inefficiencies,

Is this Holy Writ you got from somewhere? Is the mere statement supposed to disprove somehow the Austrian explanation? Because I don't see how it does.

a low interest rate makes it more efficient,

We went over this earlier, silly. You are supposed to be convinced by now.

but there must be adequate regulations preventing greed from taking over.

Wait a minute. I thought the regulations are to make sure "liquidity isn't used for destructive and destabilizing specualtion." Now it's to prevent greed from "taking over". How will greed take over if there are no regulations? What does "take over" mean?

So this was the best you could do, hey? Totally shattered the ABCT, haven't you?

Re: What's the counter argument?

fakename — Sat, 09 Jan 2010 23:46:02 GMT

But don't forget krugman's response:

Because all income is someone else's income therefore if there was a glut in investment wouldn't we see a depression in consumer's goods and vice versa?

But this argument is by itself, a little flawed too.

Re: What's the counter argument?

Esuric — Sat, 09 Jan 2010 23:21:17 GMT

The Late Andrew Ryan:

So, I've finally come to see that according to Austrain theory the major reason for the buisness cycle is the tamperings of the central bank and its manipulation of interest rates.

What I want to know is what is the rebuttal to this? The Austrian theory surrounding the interest rates is so simple when you get right down to it, and makes so much, well.... Sense, that I should think that there would be a good theoreticle reason why other economic schools don't have this same view of the interest rate, and what they're justification for it being an arbitrary tool for economic manipulation by the central bank.

Here, Keynesian drone response:

The interest rate is only the return to financial assets in the bond market and has nothing to do with any real economic phenomena. Furthermore, there are many different interest rates for many different assets, and are funneled through many different channels. To speak of "one interest rate" is to speak nonsense. The interest rate doesn't equilibrate the market, as savings only equals investment after the fact through necessary business adjustments; it's more accurate to say that savings is truly a function of income. Additionally, interest rates should be low at all times in order to facilitate investment, but regulations must be installed so that liquidity isn't used solely for destructive and destabilizing speculation. Business cycles are bound with capitalism and all of its inefficiencies, a low interest rate makes it more efficient, but there must be adequate regulations preventing greed from taking over.

Re: What's the counter argument?

LvMIenthusiast — Sat, 09 Jan 2010 23:08:27 GMT

Also, there does not have to be a central bank to commence the ABCT....

It can happen on a much more local level, in a free-banking society as well. But, again there is a much more intricate argument that entails as well with this too.