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Source link: http://archive.mises.org/11397/do-innovations-cause-business-cycles/

Do Innovations Cause Business Cycles?

January 7, 2010 by

If one considers the relatively poor tools available for astronomical research in those days, Ptolemy’s fallacy is excusable. But modern economic science is not free from this kind of error either. FULL ARTICLE by Malte Tobias Kahler

{ 21 comments }

Mushindo January 7, 2010 at 8:22 am

‘Today, times have changed and the struggle for the best theory is fought not by sword and fire but by pen and paper.

regrettably, I beg to differ. Today, the struggle for the best theory is fought by soundbite, TV spots, and op-ed columns in the mainstream press, all pandering to the popular sentiment du jour.

If it takes more than a snappy soundbite or a 90 second youtube clip to articulate a complex chain of reasoning, the theory hardly gets past the walls of academia.

Does that make me a cynic or a realist?

scott t January 7, 2010 at 1:39 pm

“….nothing wrong with relying on credit in order to provide for the application of an innovative project. The problem only appears when these credits are created out of thin air, thus inducing malinvestments….”

i dont know if this is really true or not.

i wouldnt be surprised if thin-air credit (if it even takes place) has brought about innovations that generated additional wealth and profits and lower prices and the credit just eventually gets extinguished.
but i havent been able to confirm this.

“This is a brief description of the well-known process of “creative destruction” — a term made famous by Schumpeter himself.[3] The now-achieved state of equilibrium is only maintained until a new innovation creates the foundation for another boom.”

if a situation occurred where thin-air credit ,as so many have called it at these sites, was used not only to boost innovative investments but aslo used to quickly remove infrastructure from known lesser quality existing technology how can it say then that thin-air credit induces malinvestments??

scott t January 7, 2010 at 1:45 pm

“when prices are adjusted for inflation, Americans today spend ’40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car’than they did during the early 1970s.”
http://blog.mises.org/archives/010741.asp

i guess there are clothing makers food processors and appliance manufactures still profiting amidst lowering prices and within a thin-air credit banking system??

scott t January 7, 2010 at 2:01 pm

“….booms are due to technological or other innovations whose implementations at first seem to promise high profits. After a while, more and more entrepreneurs copy the strategy of the pioneer firms until competitive behavior forces profits to go down again….”

how did the all the other entrepreneurs get the money to copy the technology to create a boom rather than a few scattered personal miscalculations?

i assume there is a difference?

was the money due to the thin-air credit where fully backed reserves would make a positive difference??

do the article authors ever add input to these blogs on their articles?

i dont see it unless they use fake names.

Inquisitor January 7, 2010 at 2:52 pm

“i wouldnt be surprised if thin-air credit (if it even takes place) has brought about innovations that generated additional wealth and profits and lower prices and the credit just eventually gets extinguished.
but i havent been able to confirm this.”

Prove it. Have fun trying to establish the multitude of alternative scenarios and opportunity costs incurred via credit expansion that would be necessary to prove this in the absence of voluntarily made purchases by consumers.

“was the money due to the thin-air credit where fully backed reserves would make a positive difference??”

?

scott t January 7, 2010 at 3:31 pm

“when prices are adjusted for inflation, Americans today spend ’40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car’than they did during the early 1970s.”
http://blog.mises.org/archives/010741.asp

i guess there are clothing makers food processors and appliance manufactures still profiting amidst lowering prices and within a thin-air credit banking system??

scott t January 7, 2010 at 3:38 pm

‘Have fun trying to establish the multitude of alternative scenarios and opportunity costs ”

couldnt that just as well say multitude of thin-air credit investmetns in innovatiions?

Mike January 7, 2010 at 3:50 pm

scott t and Inquisitor,

Neat innovations get made during credit expansions all the time. That doesn’t mean they’re not malinvestments. If the project eventually fails miserably, it’s a malinvestment.

Innovations are made all the time by imaginative and industrious people. There is no reason to have periodic episodes of mass misery just so some neat trinkets like solar panels get invented (and end up unmarketable) rather than other stuff getting invented.

Justin January 7, 2010 at 4:14 pm

Scott t -

You mentioned ‘i wouldnt be surprised if thin-air credit (if it even takes place) has brought about innovations that generated additional wealth and profits and lower prices and the credit just eventually gets extinguished, but i havent been able to confirm this.’

Not all investments utilizing thin-air credit are malinvestments, so yes they can bring about wealth, profits, lower prices, etc. However, thin-air credit does cause malinvestment to the degree that it discounts interest rates. When interest rates are artificially lowered through thin-air credit, companies are more enticed to borrow than they otherwise would be in a more expensive credit environment.

Market interest rates should be a signal to companies how wealthy their consumers are. When interest rates are high, it means there is a high demand for deposits by lending institutions, signaling that bank deposits are low because the consumer population is poor. When interest rates are low, it should signal that bank deposits are high because consumers are wealthy and have been saving. These low interest rates tell businesses that consumers have the money to spend on the products they want to sell. When interest rates are artificially lowered through thin-air credit, it falsely signals to companies to invest in new products to bring to market – but when they do, consumers are poorer than the interest rate signaled, and there are not enough dollars to make the company’s investment profitable. This is why thin-air credit and interest rate manipulation leads to malinvestment.

Not all investments utilizing thin-air credit

fundamentalist January 7, 2010 at 4:25 pm

There is a long debate about whether booms create more wealth than busts can destroy. In “Monetary Theory and the Trade Cycle” Hayek theorizes that they do. One thing we know, the cycles destroy confidence in markets.

Fallon January 7, 2010 at 4:28 pm

Justin,

How is it possible for thin-air creditors to determine the natural interest rate? Even as they seek to manipulate the nominal number in their favor- doesn’t that simultaneously obfuscate the real rate even further?

DD January 7, 2010 at 4:41 pm

fundamentalist,

How can the misallocation and vast entrepreneurial errors caused by the artificially low interest rates possibly create wealth? The boom destroys wealth and the bust is just the correction process.

Hayek’s remark there is completely at odds with anything before that remark and after it. Nobody really understand what he meant by that remark.

Del Lindley January 7, 2010 at 4:53 pm

It seems to me that if Schumpeter “confined” himself to the Walrasian box during any portion of the economic cycle then he wasn’t concerned about describing a real economy. An equilibrium condition implies a state of certainty that is free of the gradients that induce dynamic flows. In a personal context an individual’s body achieves equilibrium only after death. Hence an “equilibrium model” for one’s own metabolism would be equally pointless. Furthermore if Schumpeter limited his analysis to a free market (with no fraudulent circulation credit) then ABCT would not apply, and he would then not be guilty of the “Ptolemaic” error. Again, if Schumpeter was not trying to describe a real economic system then it is important to identify all of his (unrealistic) assumptions.

scott t January 7, 2010 at 11:02 pm

“Innovations are made all the time by imaginative and industrious people. There is no reason to have periodic episodes of mass misery just so some neat trinkets like solar panels…..”

i dont know if a solar panel is an innovation or a mere invention?
an automated band saw that cuts timber faster and cheaper i would consider innovatiion…of the price-reducing variety.

“When interest rates are artificially lowered through thin-air credit, companies are more enticed to borrow than they otherwise would….”

is this then the real problem with what has been described as business cycles and the disesae and ill of inflation (described on mises and lrc sites).

enticement?

if busnissmen and DD account holders only spent ten percent of of their account balances? would they be better off?
if innovation has occurred in capital goods processing and lowered prices over the centuries wouldnt some greater knowledge have occurred in the inflation/frb and financial capital areas?

Allen Weingarten January 8, 2010 at 6:40 am

Mr. Kahler writes: We ought to consider the cautionary words of the once-proud philosopher Hypatia: “Should not reason alone be the judge?”

That is apt for the study of science and philosophy, but when it comes to explaining an analysis to the public, there is no substitute for marketing. A product is not simply a matter of its capability, but of how well it is understood, fits into the user’s way of life, and is applicable. Let us note how well this has been done by the Keynesians. They say: it is the evil of the greedy capitalists that cause recessions, depressions, and destructive policies; it is immoral for some to earn billions, while others are in poverty; this must be corrected by government, who acts as Robin Hood. (Even a high school dropout will say: the rich make all our problems; its bad for them to got so much, while I ain’t got none; so their loot should be given to the community.)

This nonsense is clear, simple, and easy to apply with regard to policies. When we are able to present our outlook in as clear, simple, ‘moral’, and applicable manner as do the Keynesians, we shall be competitive.

Justin January 8, 2010 at 8:22 am

Fallon-

‘How is it possible for thin-air creditors to determine the natural interest rate?….doesn’t that simultaneously obfuscate the real rate even further? ‘

You are correct, only the market can correctly identify the natural interest rate. This is why the fractional-reserve banking system is so ineffective – because it will always cause mal-investment to the degree in which the interest rate is adjusted away from the natural market rate.

Scott t-

The Fed manipulates interest rates in order to entice people into borrowing. If these people/businesses would have borrowed at a higher interest rate, what is the purpose of artificially lowering it? It is to entice the population into borrowing. Problem is – interest rates mean something: they are a signal of the wealth of the people. If you manipulate interest rates, you send manipulated signals and encourage borrowing at times when the population is the poorest. Interest rates are always lowered by the Fed in times of recession, enticing people to borrow when the population is unemployed, jobless, and broke.

Allen Weingarten January 8, 2010 at 11:08 am

I have an example regarding “Should not reason alone be the judge?” In ancient Greece Eratosthenes showed (by simple measurements of shadows on the Earth, and elementary geometry) that the circumference of the Earth was approximately 25,000 miles. This was not known at the time of Columbus, or he would have recognized that he couldn’t reach India by the path he took.

Reason, along with further measurements, won out, but it took an extra 18 centuries.

Inquisitor January 8, 2010 at 11:39 am

“couldnt that just as well say multitude of thin-air credit investmetns in innovatiions?”

At least that is up for their investors to determine and not nutcases/egomaniacs/scientistic idiot savants in ivory towers such as the Fed. Have fun proving that a centralised system like the Fed can outcompete a dispersed information system like the free market that captures local/circumstantial knowledge that could not even in principle be known by our ruling elite.

Inquisitor January 8, 2010 at 11:40 am

“There is no reason to have periodic episodes of mass misery just so some neat trinkets like solar panels get invented (and end up unmarketable) rather than other stuff getting invented.”

Which is what I meant by opportunity costs. “Do nothing” is also an option and perhaps the best at times.

Schumpeter February 19, 2010 at 11:09 am

What did the dot com bubble have to do with a fractional reserve banking system? The the dot com bubble was a result of irrational exuberance in equity markets, a lot of “real” cash that was looking for a home.

Schumpeter February 19, 2010 at 11:10 am

What did the dot com bubble have to do with a fractional reserve banking system? The dot com bubble was a result of irrational exuberance in equity markets, a lot of “real” cash that was looking for a home.

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