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Source link: http://archive.mises.org/4399/working-paper-on-malinvestment/

Working Paper on Malinvestment

December 4, 2005 by

Explaining Malinvestment and Overinvestment, by Larry Sechrest

Mainstream macroeconomists may–and do–disagree with such an assessment, but Austrian macroeconomists rightly consider the Misesian/Hayekian theory of the business cycle to be one of the signal achievements of the entire Austrian school of thought. This Austrian business cycle theory (ABCT) offers a unique perspective on the destructive array of private sector incentives created by central bank manipulations of the supplies of money and credit.

ABCT is essentially a theory of unsustainable economic expansions, that is, macroeconomic expansions that must unavoidably be followed at some point by macroeconomic contractions. At the center of this scenario is the phenomenon of malinvestment. Thus, in order to explain ABCT one must be able to convey in what malinvestment consists. In the past, Austrians have usually done this either entirely by means of verbal explication or with the assistance of certain unconventional constructions such as Hayekian triangles. These figures relate the stages of production to the magnitude of ultimate output and thus can reveal the effects of a change in market interest rates on the structure of production. However, to grasp the significance of such triangles one must also comprehend certain distinctively Austrian ideas such as “roundabout production” and the average production period.

Students of economics who are not already familiar with the Austrian School are thus not likely to find Hayekian triangles to be very enlightening. Something more familiar to such students might prove more helpful.

Pursuing that line of thought, the present paper will offer an interpretation of malinvestment in more conventional terms, using such frameworks as the familiar Capital Asset Pricing Model (CAPM) seen so often in finance classes. In addition, the everyday observation about the disproportionate effects of interest rate changes on the present values of assets with different maturities will be shown to be congruent with Hayekian triangles, thus removing the latter from the realm of the exotic. Finally, the important role of the “subsistence fund” in understanding malinvestment will be illustrated. First of all, however, the basics of ABCT will be briefly reviewed.

FULL PAPER

{ 1 comment }

Christopher Carr February 26, 2010 at 11:06 am

Ultimately, I support this particular stimulus only because our reckless behavior got us to a point of no return. But eventually, there must be massive restructuring and a gradual, gentle purging of toxic institutions. In the early 1900s, the Roosevelt government took over large conglomerates and broke them up. We may have to take similarly drastic action once the economy begins growing again to restore true free-market capitalism.

While Keynes and Hayek spent most of their careers in bitter disagreement, I think it’s possible that the two theoretical frameworks can be reconciled by seeing the former as for efficacious employment in emergency situations, and the latter as our ultimate long-run approach; we must take more minimalist, cautious steps going forward. Moral hazard and malinvestments have contaminated the American economy, and while there’s little we can do towards curbing malinvestments and moral hazard while things remain so fragile, the new Keynesian revival must be tempered with this realization.

http://www.theinductive.com/blog/2010/2/26/our-obese-economy.html

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