Yesterday’s daily article by William Andersson on Paul Krugman’s recent dismissal of Austrian economics as religion was quite interesting. It might seem appropriate to remind everyone of a older attack by Krugman on Austrian economics, or more specifically, the Austrian business cycle theory (ABCT). He starts the article by telling of how someone attacked him for not paying attention to ABCT, something which he explains by saying ABCT is “about as worthy of serious study as the phlogiston theory of fire”.He then goes on to reformulate ABCT as a “hangover theory” which he blames for the Great Depression, because supposedly Herbert Hoover pursued a misesian policy, something which anyone who has read Rothbard’s America’s Great Depression knows is a ridiculous assertion. He then sums up the hangover theory as follows:
“In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity–of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes–investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.”
He then says that apart from the last part about the virtues of recession this is actually a good description of business cycles.
“Anyone who has watched the ups and downs of, say, Boston’s real estate market over the past 20 years can tell you that episodes in which overoptimism and overbuilding are followed by a bleary-eyed morning after are very much a part of real life.”
But then he argues that there is no reason to assume that a investment cycle should result in a recession since a downturn in investment should be counteracted by a consumption boom.
He dismisses the Austrian explanation that this won’t happen because the shift away from investment to consumption means that the to some extent -at least in the short term- specific factors of production (both the workers and the capital goods)that previously produced investment goods will now become unemployed, thus reducing production by arguing that in that case the shift from consumption to investment should produce a bust too, rather than a boom.
Actually, that is quite easy to answer. The difference between the shift from consumption to investment and the shift from investment to consumption is that the former will mean that the amount of useable factors of production will increase (investment goods production is the production of the factor of production known as investment goods), while in the latter case the amount of useable factors of production will shrink, both as a result of reduced investment goods production and the fact that the already existing factors of production will to some extent be unemployed.
The argument that then follows from Krugman that it is not just the investment sector that contracts in a recession but all other sectors as well and that the investment cycle therefore cannot explain recessions is equally invalid. The relative spending on consumption always increase during recession, but it is just that because of the reduced purchasing power resulting from the contraction in the investment goods industries, absolute consumption spending might fall anyway.
His last two paragraphs contains the myth that Japan following the bursting of their stock- and real estate bubble in the early 1990s pursued a misesian policy. Which is certainly not true, as Japan has increased the deficit to a higher level relative to GDP then even Bush has managed to achieve and as the Bank of Japan has cut interest rates to zero and tried hard to expand the money supply, although admittedly these attempts have been to a large extent unsuccessful because the sharp increase in the monetary base have been counteracted by declining bank lending.
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From the quotes provided, it sounds like Krugman hasn’t even read the work on the ATBC, and only has some vague idea of what it is, based on misrepresentations that may have been presented to him by others. It isn’t the Austrians that can be dismissed out of hand, but Krugman any time he’s talking about them, as he obviously hasn’t read them (or if he has, very carelessly).
“Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory.”
Isn’t this “excess demand” due to the need for money to pay for unwisely (not to be too pejorative about it) incurred debts?
I admit that I am not an expert in ABCT, but Krugman’s incantations appear to verge on witchcraft. Certainly, in his view, ABCT is way too simple – almost everyone can understand it in general terms. If that were the accepted view, there would be a major depression in the High Priest of Economics profession.
Professor Krugman is clearly on a roll in his earlier 1998 essay “The Hangover Theory…Are Recessions the Inevitable Payback for Good Times.” One definitely gets the feeling he has never had a good hangover, a most priceless learning experience, and that he really enjoys attacking the Austrian School and ACBT…maybe a little too much.
Of course, his endorsement of governmental interventionism in the economic life of a nation is a popular idea that never seems to run out of steam, arising I think from a whole lot of hubris and a “do something-I don’t care—anything” type of attitude, strongly abetted by the good old-fashioned expediency of the political class to show something tangible—hey!how about another 3000 page law—for all the time they spend in Washington.
A modern economy is a gargantuan complex and to think that there might be economic-priests who can manage it by some tweaking here, and injecting a little more play money there, and then for good measure ratcheting up the minimum wage while slapping tariffs on some foreigners stealing American jobs—-well, even for this amateur economics student it gets to be very suspicious, and ultimately comical.
I like Brian Gladish’s question in an earlier comment, which in its straightforwardness must seem to a Keynesian economist like a bullet between the eyes: “Isn’t this ‘excess demand’ due to the need for money to pay for unwisely…incurred debts.”
[Not to mention that pesky "excess demand" for money due to the fact that it is constantly losing its puchasing power as a result of all that helpful tinkering.]
I have a question, too, since I must admit I didn’t understand Professor Krugman’s 1998 essay, whereas I can make at least some sense of Austrian Business Cycle theory: Doesn’t it seem reasonable to assume that savings accurately reflect the extent to which new goods and services could be actualized in excess of what already exists? I mean, if we can’t save a dime, doesn’t that mean we are already strapped to the max, that the conditions and resources possibly don’t exist yet for us to expand our economic base at a natural, sustained rate?
No false tinkering with creation of credit in a fiat money system can alter that fact, it can only make our plight worse by bidding up prices. That tinkering is what has made it so difficult to save in the first place.
Or am I mistaken?
Krugman’s comments remind me of today’s Mises article in which Ludwig von Mises demonstrates how Keynes set up a straw man in his supposed discrediting of Say’s Law. Krugman truly is ignorant of the ATBC, so he makes up his own version, then attacks it.
While this is an interesting device for setting up an argument, it is fallacious to the core. But, then, I stand on my previous statement: Paul Krugman is NOT an economist. He is a political operative, and that is all that he is.
I always thought that in order to rationally agree or disagree with a concept, you must first understand the concept. This of course assumes that intellectual inquiry and knowledge is your goal. If smearing someone or his beliefs is your actual goal, then deliberately misstating or creating your own version of that person’s argument serves a purpose, as noted by Professor Anderson. Of course, this type of tactic lacks integrity, but who cares about integrity when political goals are of overriding importance.
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