Most people would find it strange to hear about potential problems with a booming economy these days. After all, we are in the midst of a recession and some people fear the onset of a depression like deflationary collapse. It is however, worth noting that the Federal Reserve Banks has cut The Federal Funds Rate half a point to 1%. This is the lowest level for this rate since 2004. The Fed is moving aggressively supposedly to save the economy from its current dire condition. What the Fed is actually doing is interfering with adjustments in markets previous cuts in interest rates. It is setting the stage for another boom in the economy, to be followed by a recession. The business cycle does follow a fairly discernable pattern, in the aggregate. The Fed finances booms with bank reserve expansion and reduced interest rates. As inflation becomes more obvious the Fed then hits the breaks, thus causing yet another perceived crisis.
What we need to recognize is that the actions of the Fed today are not correcting markets and saving us from further failure. The manipulation of interest rates by the Fed are distorting capital markets, this manipulation is preventing capital markets from sorting out the last set of errors that the Fed created with the artificially low interest rates it set back in 2004 (among other times).
The real solution to the problem of the business cycle is to recognize the true function of interest rates. The Federal Reserve is being run according to the Keynesian idea that interest rates function as a mechanism for stimulating or chocking off aggregate demand. Now that aggregate demand appears insufficient, Ben Bernanke is moving to stimulate the economy. At some point some years from now Chairman Bernanke or his successor will find that aggregate demand is excessive, and will raise interest rates to a point where capital markets will crash and a recession will ensue. What is missing in Chairman Bernanke’s analysis is the idea, developed by Mises and Hayek, that interest rates coordinate the planning of future economic activity among and between individual households and businesses. Interest rates and credit markets facilitate exchange between savers and borrowers as people plan out future production and consumption. Interest rate manipulation does not simply choke off or stimulate aggregate demand, it causes dis-coordination between individuals who trade in credit and capital markets.
Ben Bernanke is now charting a course that will lead to yet another boom, a corresponding period of perceived prosperity only part of which is real, and yet another crash and recession. Hopefully the next recession will do less undeserved damage to the reputation of capitalism and free markets. Better still we can hope that more people will realize that it is Federal Reserve policy, based on faulty Keynesian economic reasoning, that is to blame for the business cycle.
(DW MacKenzie teaches economics at The Coast Guard Academy. The views of this paper do not represent the official views of The Coast Guard Academy.)
{ 39 comments }
Will be interesting where the money will go.
I truly feel sorry for your students. Do you teach “Creation Science” to the Coast Guard as well?
it remains to be seen whether this monetary stimulus will in fact create another boom. As Shostak has pointed out, banks are not lending the green dollars.
Other than that, I agree with what you wrote.
George T: I am an agnostic but at least I’m a polite person.
Hey MacKenzie, my university could use more teachers like you. Keep up the good work.
Hey MacKenzie, my university could use more teachers like you. Keep up the good work.
Yep. We’re certainly not headed for a depression yet. Look out for helicopters cause the overnight rate is going to ZERO possibly even lower.
If you’re looking for the Fed to tighten rates, I wouldn’t hold my breath, but you wont be able to get credit either unless you are a major bank.
The Communists have stated numerous times that they will not be satisfied until they have destroyed all private capital. They wont stop until we are all on the bread line.
Just look what they did to Argentina, Japan, Zimbabwe or any number of other countries.
George T, did you not read the “Intelligent and civil” part of the “post a comment” section? Such an a baseless attack is foolish.
Keep up the good work, G.W. Mackenzie.
“After all, we are in the midst of a recession and some people fear the onset of a depression like deflationary collapse”
Deflation sounds really good right now, with gas coming down I hope food comes next. Aren’t these bubble bursting deflation(s) a good thing from an Austrian perspective? http://mises.org/article.aspx?Id=1241
Deja-vu all over again?
Albert Einstein defined insanity as doing the same thing over and over again and expecting different results.
Here is Mildred Bailey’s ringtone of the Federal Reserve anthem
http://www.youtube.com/watch?v=vzrSxLwo3BU
DW MacKenzie what is your opinion on Steve Forbes solutions in the latest issue of Forbes? I think there is a practical fact that the FED will not be eliminated any time soon. But a policy of tying the dollar to gold at set price range along with maintaining and stating a strong dollar policy might be a step in the right direction. His other comments on reforming accounting rules with the elimination of the mark to market on the financial assets, mortgage backed securities, as well as repealing the Sarbanes Oxley law.
Deflation sounds really good right now, with gas coming down I hope food comes next. Aren’t these bubble bursting deflation(s) a good thing from an Austrian perspective?
No. It means people can still survive, but prices are only dropping because of drastic decline in demand, which means that standard of living is declining.If people return to their previous lifestyles prices would be through the roof.
As far as Lew’s comment about prices dropping in the computer industry, it is not because of a decline in demand or because of decreasing money supply, but because of the following factors:
1. There is virtually no regulation in this industry.
2. People in IT work 10-20 times harder than the average person because it is extremely competitive.
3. As a general rule, software developers and electrical engineers are the most intelligent and creative class of life on planet earth.
4. The hundreds of billions of dollars worth of software that has been produced in the last few years via the anarchist concept of mutual aid (i.e. open source software).
The natural tendency of prices in a free market is asymptotic (towards zero) while wages rise exponentially. The IT market is simply freer than others, but by no means completely free. If we were completely free w would most likely be living like billionaires and working a few hours a year, given the technology we have now.
A distinction needs to be made between deflation[productivity gains], deflation[shrinking demand], deflation[decrease in money supply]. The latter two represent the elasticity in demand but the former can only be measured accurately by accounting for changes in demand and the money supply.
George T: Are you on the right website?
Great article DW.
“I truly feel sorry for your students. Do you teach “Creation Science” to the Coast Guard as well?”
Why don’t you elaborate on those “thoughts” of yours?
With yet more increases in moral hazard and the tremendous increases in the money supply that will be relatively greater than the destruction in credit, greater booms and busts are likely down the road, say 2-3 years – I wrote about this myself not long ago….
I don’t see how we can’t escape at least a severe 1-2 year recession and I think the Japanese decade long deflationary recessionary scenario is a risk, but not as likely as another (bigger) boom bust scenario down the road – there is just too much pressure to reinflate the global economy, and the USA is the “relatively least miserable” (as I like to say) when it comes to attracting capital on a global scale.
Moral hazard is the operating factor. People are still going to get out and take credit. You can’t afford not to. You heard it here first. The discount will be one half of one percent by the April FOMC meeting.
Anyone want to place bets?
“No. It means people can still survive, but prices are only dropping because of drastic decline in demand, which means that standard of living is declining.If people return to their previous lifestyles prices would be through the roof.”
But isn’t the fact that even this type of deflation a good thing? The ABCT identifies the boom period as the impoverishment, malinvestment, and capital consumption period, where as the deflation during the bust phase is a sign that the market is correcting itself to its real preferences, and real growth can occur once the prices are correctly realigned. I see what you mean that this deflation is not a real increase in productivity, but I still think its a good thing because corrections are happening and real productivity can began, while providing some relief for consumers for the time being.
“The natural tendency of prices in a free market is asymptotic (towards zero) while wages rise exponentially. The IT market is simply freer than others, but by no means completely free. If we were completely free w would most likely be living like billionaires and working a few hours a year, given the technology we have now.”
I have my doubts that the tendency of prices in a free market is toward zero. This article tells me something different http://mises.org/daily/2971
But I agree that in a free market we will have access (over time) to the wealth that billionaires have today.
Thanks for your thoughts and explanations, and you’re right, more distinctions on different types of deflation would be useful.
More like a mini-boom. There has never been this much inflation in the US economy. We have yet to see the price rises as a result of this. We have a central bank reading the correction in asset prices as a signal that the market needs more liquidity. This wealth transfer will only show up as a slow growth in prices. Energy is going down but food isn’t. Nor is clothing or other products.
As clicking on my name demonstrates, D. W. MacKenzie is indeed teaching an exploded and illogical theory.
Eric,
As far as realizable reforms are concerned, I favor a return to the gold standard, as well as a repeal of Sarbox, replacement of the current tax code with a simple flat tax… One area where I disagree with the Forbes crowd as far as short term solutions are concerned is with education vouchers and school choice. Such vouchers would be a new entitlement, but that’s rather off topic.
DWM
Eric,
As far as realizable reforms are concerned, I favor a return to the gold standard, as well as a repeal of Sarbox, replacement of the current tax code with a simple flat tax… One area where I disagree with the Forbes crowd as far as short term solutions are concerned is with education vouchers and school choice. Such vouchers would be a new entitlement, but that’s rather off topic.
DWM
Robert,
I do not find the abstract to your article convincing. Is the full article published anywhere?
DWM
Their goal is to maintain their political power. Economic properity tends to make that easier to do (and also allows for even more political power), but now that the pyramid is collapsing, the goal is to shore it up enough to get through the next election and continue in power. Economic prosperity, other than for themselves, was never a goal, only a marketing tool and a useful side effect.
After this election, the goal will continue to be the same.
The next recession will be catastrophic and this time there will be no easy way out, no stimulus package, now rates cut etc.
So I’m investing and buying into the market now and at mid-course of this boom I will sell my stocks and buy gold.
Then when the market collapse I will have lots of gold and I will be invulnerable to government monetary policy.
By the way, hyper-inflation is coming, so the boom will last shorter.
Have you noticed that the boom-bust cycle is more and more violent and shorter in duration.
Robert V. Have you tackled the criticisms of the the anonymous referees? Those that you mention here:
http://robertvienneau.blogspot.com/2008/09/rejection-by-review-of-political.html#links
Robert, why don’t you post your ideas go Garrison or Yandle or Reisman or Murphy and so on and stop posting them on a blog where no one gives two shits about you or your alleged discoveries? We don’t have time for every crank who thinks he’s “refuted” the ABCT. Go bother an economist who thinks you actually have a case, silly pest.
“If a strong challenge was mounted in this essay, it was beyond my ability to grasp it.”
LOL Yeah, it must be because Robert’s argument is so transcendental and obviously beyond the ability of mere mortals to comprehend. Or maybe even a sympathetic referee thinks you’re full of shit. Poor Robert.
For what it’s worth Robert’s paper makes some good points.
The idea that the natural rate of interest is really equal to what the interest rate would be in a barter economy is very dubious. Many Austrian economists realise that now though.
Lachmann’s criticisms which are quoted are also important.
There are indeed many problems with Hayekian triangles and some austrians have abandoned them. I’m suspicious of them but I haven’t decided either way yet.
Much of the rest is wrong though, for reasons the anonymous referees mention. Also, the examples used to attack ABCT uses the “Constant returns to scale” assumption in a dubious way.
Agreed. In fact I am not aware of an Austrian who holds those ideas anymore, if some did in the past.
DW MacKenzie: The full article has not been published. It is downloadable from SSRN look on the upper left of the page from my previous link.
Current: I have a revision where I have attempted to respond to all reviewer comments. I have yet to submit it to a journal. Unfortunately, by deleting the lengthy literature review, I no longer point out areas of agreement between Joan Robinson and Lachmann and between Keynes and Hayek. If I allowed for non-CRS, I would have greater flexibility in the analysis of the choice of technique. My argument would be strengthened, not weakened. I’m not sure I should include a footnote to this effect in my new revision.
Inquisitor: Murphy has seen a previous version, and I believe the same is so for Garrison. I’d like to hear some more of your comments, since I always like to laugh.
When (and IF) your article gets taken seriously, and when (and IF) the argument in it is judged as sound, then you may laugh. Until then you’re one of many who claims to undermine neoclassical/Austrian econ. Good luck with that, don Quixote.
I guess I may be free to choose, but I am not free to laugh.
Is it possible to figure out where the money goes? Other than that it probably goes into capital goods? But which ones? For example, are there any available statistics that show growth per industry?
Robert: “Current: I have a revision where I have attempted to respond to all reviewer comments. I have yet to submit it to a journal. Unfortunately, by deleting the lengthy literature review, I no longer point out areas of agreement between Joan Robinson and Lachmann and between Keynes and Hayek.”
Perhaps split it into two papers, one on the history of the subject and a second on your proposed contribution to it?
Robert: “If I allowed for non-CRS, I would have greater flexibility in the analysis of the choice of technique. My argument would be strengthened, not weakened. I’m not sure I should include a footnote to this effect in my new revision.”
Looks carefully at the assumptions from which you build your Sraffa system. What you have done is to remove decision making in places where it would exist in practice. If you’re interested I’ll describe more.
You are right in the complaints about Hayekian triangles that you draw from it though.
Robert,
you have three general problems with your article.
1. Empirical significance. I agree that J Robinson demostrated that the conclusions drawn from Robert Solow’s capital theory are not general, they do not hold 100% of the time. Austrian capital theory is quite different than Solow capital theory, and in ways that make it somewhat less suceptible to your type of critique. Austrians have always recognized aggregation problems. But how much of a problem is this for either Solow or Hayek? How often does reswitching occur in the real world? To what degree have these problems impeded real world economic development? The CCC debate was mostly theoretical, I am not familiar with any applications of these issues to real data.
2. Is there a feasible alternative to market planned capital investment? Can the state do better than the market? Real world examples of state planned capital investment indicate that the market is not so bad after all. There are real public choice problems here. See my paper on Capital and Income in Democratic Socialism here: http://mises.org/periodical.aspx?Id=7&author=DW%20MacKenzie
3. Who else might publish your article other than ROPE? I know the eds at ROPE (Mongiovi and Pressman) and they are interested in these issues. Few other editors will give a CCC/reswitching article any serious consideration. The CJE or the Review of Social Economy might I suppose. But if Mongiovi and Pressman turned you down that is a bad sign.
DW McKenzie:
“2. Is there a feasible alternative to market planned capital investment? Can the state do better than the market? Real world examples of state planned capital investment indicate that the market is not so bad after all. There are real public choice problems here. See my paper on Capital and Income in Democratic Socialism here: http://mises.org/periodical.aspx?Id=7&author=DW%20MacKenzie”
That question though is really separate from the strictly economic question. It is still useful to know if the interest rate could be used to cause this or that were an be set by incorruptible gods. Since it informs other parts of economics and other subject for investigation.
DW MacKenzie gives me three numbered points.
(1) seems like a mixture of points to me. These points are addressed in my paper. And one of the two referee reports linked to above agrees with me.
(2) is a non sequitur. My paper is not titled, “What is to be done”.
(3) is irrelevant to the validity of my argument. Maybe DW MacKenzie merely means to give me advice on where I might get this article published.
“Current” gives me some advice. I’m not at all sure that the literature survey constitutes a legimate contribution to history. I’m content with trying to get the remainder published to start.
I think of a continuously differentiable production function (for a non-vertically integrated industry) as specifying a uncountably infinite number of processes, each with coefficients of production, perhaps as a function of scale. I do not see any point of principle in such a specification of technology and the discrete specification with few processes that I use. My argument goes through either way. I thought I claimed that out in the conclusion section.
Admittedly, this analysis does not include, for example, learning by doing in a setting of historical time. But neither does the formulation of ABCT in the expositions I attack.
Robert: “Current gives me some advice. I’m not at all sure that the literature survey constitutes a legimate contribution to history. I’m content with trying to get the remainder published to start.”
Fair enough.
Robert: “I think of a continuously differentiable production function (for a non-vertically integrated industry) as specifying a uncountably infinite number of processes, each with coefficients of production, perhaps as a function of scale. I do not see any point of principle in such a specification of technology and the discrete specification with few processes that I use. My argument goes through either way. I thought I claimed that out in the conclusion section.
Admittedly, this analysis does not include, for example, learning by doing in a setting of historical time. But neither does the formulation of ABCT in the expositions I attack.”
In the example you give the market isn’t really tending towards an ERE. In each successive year less is produced.
There are other problems:
* Is what you describe the whole economy?
* How many entrepreneurs are there overall?
* If there are more do they all face the same situation as this one?
* In each year the decisions taken on the amount of labour applied to the production of each commodity should depend on profit possibilities
* You only have one consumption good and two capital goods. This is unrealistic. It partially resurrects the labour theory of value.
Robert should take note of the fact that my first and second points are closely related. The empirical significance of reswitching has to be weighed against the feasibility of directing investment through some alternative means (i.e. government planning). Robert should also take note of the fact that this thread is about my article on Mises.org, not his article that was rejected by ROPE. He entered the fray here with the claim that Austrian Capital theory is debunked and useless for the policy analysis aimed at in my article. This makes the question of “what is to be done” relevant.
Reswitching is a theoretical possibility which “exists” within particular math models. The ability of government to outperform real world capital marekts is still far from proven.
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