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Source link: http://archive.mises.org/8926/consumers-dont-cause-recessions/

Consumers Don’t Cause Recessions

November 11, 2008 by

The circular-flow diagram is a very misleading model of the economy. It leads us to think that output of finished consumer goods can immediately rise and fall with “spending.” This framework would hold if there were no capital goods, meaning that all consumer goods and services were produced immediately, as workers took gifts of nature and produced the finished item on the spot. FULL ARTICLE

{ 70 comments }

Stanley Pinchak November 12, 2008 at 12:25 pm

Pete,
with regard to presently unused capital and consumer goods, these are the result of entrepreneurial error. If the central bank comes in and increases the money supply which allows consumers and other entrepreneurs to purchase these goods, what you have done in effect is prevent the earlier misallocation of goods and underlying unbalanced structure of production from being liquidated and rearranged in a manner most suitable for the preferences of the economy as a whole. It is basically the same thing as reflation at the onset of a bust. Mises and Hayek both warn against using artificial increases in the money supply for the purpose of “soaking up” the excess inventories and unsold goods. It boils down to intervention preventing the true values of consumers from being heard by entrepreneurs.

Campbell November 12, 2008 at 3:11 pm

I loved this article… but you missed an important and simple point.

When people save their money, where do they save it? In banks. And even in Krugman’s world, banks make money by lending that deposited money out to others who want to spend it. In this sense, saving IS spending, only with the filter of the bank manager who tries to ensure the money is only spent on things that will provide a return in production for the national economy.

I’d love to be in Krugman’s class when he teaches his favorite lesson. One question would lay the whole thing bare: “but what does the bank do with the money that people are saving?”

Bob V November 12, 2008 at 10:01 pm

Stanley Pinchak said: “does the money for debt repayment magically disappear?”

Who said it disappeared?

SP said: “Does it not add to someone’s current stock of money making it available for immediate consumption, or future consumption?”

Not necessarily. It may go to pay for past consumption of labor and other factors, which then may go to pay for further past consumption of goods, services, labor, factors…which may go to pay for even further past consumption….

The problem today is debt. Until debt is cured, present consumption must be reduced and there can be no savings. Until the hole is filled, you can neither cover the hole nor build above it. Krugman seems to think that increasing debt, by gov’t spending, will increase present consumption. But all it will do is increase overall debt, thereby decreasing overall savings and consumption.

SP said: “Furthermore, should that money disappear (in the case of fractional reserve banking monetary contraction), does this not have the effect of increasing the purchasing power of the remaining money in the economy? Is this not a similar effect that saving and investment have on the purchasing power of money? Doesn’t this send all of the signals of increasing real wages and encourage the Ricardo Effect?”

Please tell me who, other than those few who were wise enough to short the bubble, are experiencing “signals of increasing real wages”? No one in my business is; and no one I know, in any other business, is?

How can money disappear, in a fractional reserve regime, before debt has been serviced? Isn’t it the servicing of debt that brings the money back within the grasp of the Fed?

Inquisitor said: “Um, if someone is being paid for debt owed, one would think they’d have money flowing in their direction… wow, what a calamity/conundrum!”

What can possibly be the relevant point of this wisenheimer remark? The statement was made that “people cut back on present consumption in order to be able to “spend money” in the future.”
My question was, is it not possible that people cut back present consumption in order to spend money in the past (i.e., pay off debt).
It is my understanding that the past is neither the present nor the future.

Daniel M. Ryan November 13, 2008 at 8:37 am

Amazing how the “mainstream” discovers the structure of production when it’s time to lobby for a bailout…

Michael A Clem November 13, 2008 at 8:52 am

Bob V, the point of their comments is that while they may be paying down debt, or past consumption, they are doing so in the present, and that money is available to the paid creditors NOW, not in the past–the money doesn’t disappear into the past or anything.
As for debt, the only problem with debt is when you get more than you can handle. And we as a nation certainly seem to have that problem.

Bruno Nunes de Paula November 13, 2008 at 9:58 am

Ok, but …
In times of recession, if you were Walmart, would you continue to buy the same amount of TV’s to sell in your store ?
That’s the major point of the Keynesian theory that wasn’t analysed very well in this article.
You’ve just said bull-shit about Keynesian and didn’t mentioned the most important part of the General Theory: The expectations.

In this crisis, you can see empirically that because of bad expectations, most of the companies aren’t producing in the same way because they know that the national income won’t be in a level that is enough to buy all their production.

The companies’ decision on how much to produce is intimate with the expectation about the future demand. It’s just a part of the called “The Principle of Effective Demand” (III Chapter – General Theory) …

Greetings from Brazil.

Bruno Nunes de Paula November 13, 2008 at 10:09 am

I agree with you that the physical production is a function of the factors like labor, capital and tecnology, Y = f(wL, rK, zT).

Although, the decision to initiate the production (i.e.: to hire workers, to get a loan, etc.) is a function of the business men’s expectations about what they think the aggregated demand will be.

They just decide to produce because of the estimated profit, and they won’t produce if they don’t think that the profit won’t come…

It’s simply, but the author of the article didn’t went well in the attempt to put this keynesian principle down…
Sorry, but you could’n convince me. :(

Jean Franklin November 13, 2008 at 1:06 pm

Out here in SubPrimurbia, we were only spending because we had lots of credit cards and refinance cash. Then a couple of years ago our all-knowing Congress decided to “help” us pay down our excessive debt by forcing banks to increase the minimum monthly payment, roughly from1% to 2% as I recall. This wrecked havoc on Joe the Plumber’s budget but I guess it didn’t affect Mr. Krugman, who probably hasn’t run up credit card balances equal to his yearly income. The lights are going on all over America (thanks, Dave Ramsey) and the little guy is figuring out that the game is rigged.

james Macinnis November 13, 2008 at 4:18 pm

Recessions are a demonstable effect of the Keynsian paradox of thrift. Private investment and consumer confidence declines. Productivity is wealth. However, it makes no sense for a manufacture to produce products for which there is no demand, there must be a demand for the product in the first place. A laid off worker not only ceases to produce, his loss of disposable income dictates that he ceases to be a consumer also and this erodes demand further. The keynesian paradox of thrift merely shows how conservative consumer spending impacts productivity and the multiplier effect reverses.The marginal propensity to consume modifys this somewhat but in the extreme the economy ratchets downward.

Monetary policy does not allways work because as the saying goes, you can lead a horse to water but you cannot make him drink. Private spending being in decline, the Keynesian remedy was government investment in public works, things that have a fuctional utility so that the investmet is in fact , backed up by intrinsic value and adds to the capital stock and wealth of the nation.

It amazes me how many people when they quote Keynes, they do so by taking him out completely out of context. Keynes did not support wasteful and indiscriminate spending. The more I study Keynes the more I am convinced that those who critique him never comprehended what he said in the first place.

Cadavre November 13, 2008 at 11:29 pm

We’re not consumers. We’re the producers. It’s our toil, our sweat, our investment that’s bailing out this criminality the War and Oil Exchange hopes we confuse as government.

We are the owners, lock stock and barrel, of everything we see, hear and smell.

When a news man, like Kieth on MSNBC who does little more than exaggerate the lie and minimize the truth keeps his mouth shut about the oligarchy, and instead, passes gossip and bovine excrement sanctimony as news and editorial, Kieth is covering up the fact that you and I are paying his employer, a true consumer, General Electric 128 Billion Dollars.

Everything is BS.

How to make these low iodine a-wipes understand we mean business without pressing our point and hanging them up like Italians did Mussolini is the issue.

We need to strike – quit buying – quit paying – quit doing. And most of all, until we get the facts about 911 out in the open, we will never be the nation our forefathers murdered so many to create.

How often does a president’s brother, like Marvin Bush, become security honcho of an alleged terror target (WTC)?

How often does a disease like Larry Silverstein buy twice condemned for asbestos towers while under waiver one month before an alleged terror attack and be the only property owner on Manhattan to have the precise kind of double indemnity insurance policy to cover so precisely the events of that day?

How often does a man like Larry Silverstein confess that he “regrettably” had to “pull” WTC, supported by first responder testimony and video evidence get called a liar by a government agency, NIST, seven years after the fact, claiming the cause of the collapse was a never before documented “miracle” of thermal dynamics, due to a failed sprinkler system, “thermal expansion”?

Had the sprinkler system been working, what are the odds NIST would have declared the failure another undocumented phenomena, despite Silverstein’s confession, “thermal contraction”?

On September 10, 2001 Donald Rumsfeld delivered a report describing a missing 2.3 Trillion dollars from DoD accounts, and then the next day, a plane not yet revealed, crashes precisely into the special auditor’s office, killing all auditors and destroying all computer records of the investigation into the “missing” trillions?

How can big heavy commercial airliners penetrate the most expensive air defense system in the world and fly right through 3 concurrent air defense drills going on at that precise moment?

Why would the FAA, in the spring of 2001, quickly implement a policy requiring air control towers to turn off their radar and rely only on transponders for tracking?

Why does one FAA controller, Pete Zalewiski, have the distinction of being the only FFA controller to be in voice contact with every alleged hijacking in the US in the last 22 years?

Why did Ambassador Amitage, after the Taliban had met with DoE and Unical officials, in Houston, August, 2001, threaten to bomb Afghanistan back to the stone age for refusing to allow a Unical pipeline right of way through Afghanistan?

Why didn’t someone take advantage of a technology installed on all US airlines for the last 30 years, a remote control and programmable flight control system, to prevent the planes from crashing into the WTC and Pentagon office, where, incidentally, the former CEO of the company that invented those “remote” flight systems, Dov Zacheim, who was [also] the “subject” of the audit, reported by Rumsfeld on September 10, being conducted in the office the yet unseen plane struck?

Why are so many comments here wasting iambic on the minuscule tedium of the spoon fed distractions of the plutocracy, and their information ministries, when any claim you may have had as a sapient human being evaporated like steel beams drenched in thermate?

We deserve to be called consumers. We deserve the boxcar trip to FEMA corrals.

You know why this has happened, but you dare not whisper it. so I’ll say it for you:

911 was an inside job – and nothing else – nothing in heaven or on earth matters until the executioner’s apprentice cleans the blood off the guillotine for that crime and the millions of murders that [still] follow it!

How do you live with yourselves and fears dressed with petty nuanced gossip?

You don’t sound smart – you sound scared!

Mark November 15, 2008 at 10:50 am

Not so fast. Here’s what you don’t account for: the world is OVER capitalized and filled with excess capacity in just about every sector.

Proof of over capitalization can be seen in two ways. First, interest rates are approaching zero. Second, the availability of the nth iteration of nearly everything. e.g. We don’t simply have lots of gadgets, we have n levels of gadgets within the gadgets, and n level of gadget holders for each, and gadget organizers for the holders, and colors and materials of choice for each.

Now, everyone of those nth iteration manufactures sinks capital somewhat equally, even though utility declines to the point of simple waste. For instance, a machine tool to make the plastic case for the nth version of a 90-cent room air freshener has the same capital cost as perhaps a mold to make a life-saving pill.

That’s an expression of capital chasing a rapidly sinking utility in search of some return better than the almost zero interest available. In short, there is simply so much capital it can be wasted. QED: the current economy of consumption – even at fantastic rates – can’t begin to keep up with production capacity. In order to have ANY return on capital, consumers need to literally accelerate a buy–consume-dispose cycle, without which, returns on capital collapse. Too much of a good thing.

Pete November 17, 2008 at 10:28 am

Stanley Pinchak,

Thanks for the comment. Where should I go to read Mises comments on the situation? What book did he talk about that in?

Stanley Pinchak November 17, 2008 at 12:30 pm

Pete,
Mises covers this feature which may occur (and to some extent always seems to occur) at the start of the business cycle in Human Action p. 580. His earlier work, On the Manipulation of Money and Credit, covers this as well on p.125 (according to De Soto, I have only read the excerpt). Furthermore, Mises warns against contra-cyclical policies in Human Action on p.798-800. I also recommend De Soto’s, Money, Bank Credit, and Economic Cycles. He distills much of the Austrian perspective on details of the business cycle including this aspect in the chapter, Additional Considerations on the Theory of the Business Cycle, in particular p. 440-443.

Jeff Osborn November 24, 2008 at 6:31 pm

It is difficult to understand how won can propose unfettered, unregulated free markets as anything but disasterous give the last 14 months and the nationalization of AIG et al.

Mr.huh? November 27, 2008 at 2:01 pm

Because Mr. Osborn the government has thousands of pages of economic regulations covering all sorts areas from the environment, monetary policy, labor, price controls, etc. plus the Federal Reserve, numerous subsidies from the taxpayers to numerous industries, bailouts, etc.

Austroglide December 3, 2008 at 1:53 am

Bravo, Mr. Murphy. I applaud your search for truth, and for sharing the fruits of that search.

How, upon close inspection of the Austrian theory by Mr. Krugman, could he possibly not find it superior to his own?

Surely it is out of ignorance of the theory that Mr. Krugman continues his steadfast adherence to his static, brittle, and indeed fatally flawed model.

Though, I would certainly be curious as to Mr. Krugman’s response if/when he ever is exposed to the full Austrian theory. Will he be swayed? What serious objection could he honestly muster against it? Here’s wishing him the good fortune of finally hearing the Austrian’s view.

Christine December 23, 2008 at 11:40 am

I’m confused. From what I have read of Krugman, I thought that he had determined that the control of the Federal Reserve had countered the paradox of thrift. Just after the quote from his op-ed that you site is a continuation:

“At this point, however, the instructor hastens to explain that virtue isn’t really vice: in practice, if consumers were to cut back, the Fed would respond by slashing interest rates, which would help the economy avoid recession and lead to a rise in investment. So virtue is virtue after all, unless for some reason the Fed can’t offset the fall in consumer spending”

and further, in Vulgar Keynesians, Krugman’s 1997 essay on the misuse of Keynesian theories:

“What has made it into the public consciousness–including, alas, that of many policy intellectuals who imagine themselves well informed–is a sort of caricature Keynesianism, the hallmark of which is an uncritical acceptance of the idea that reduced consumer spending is always a bad thing. In the United States, where inflation and the budget deficit have receded for the time being, vulgar Keynesianism has recently staged an impressive comeback. The paradox of thrift and the widow’s cruse are both major themes in William Greider’s latest book, which I discussed last month. (Although it is doubtful whether Greider is aware of the source of his ideas–as Keynes wrote, “Practical men, who believe themselves quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”) It is perhaps not surprising that the same ideas are echoed by John B. Judis in the New Republic; but when you see the idea that higher savings will actually reduce growth treated seriously in Business Week (“Looking for Growth in All the Wrong Places,” Feb. 3), you realize that there is a real cultural phenomenon developing.”

Am I missing something? I am merely an amateur student of economics (pre-Econ 101), so I would welcome a deeper understanding, as I seem to see Krugman as NOT blaming the consumer and in fact calling for Federal action.

Again, from his Oct 31 Op-ed:

“The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response…what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.”

Please shine a light.

Christine

http://theniftythrifty.blogspot.com

Gil January 15, 2009 at 5:11 am

Uh huh! Mises.org has fallen under the Skeptical Optimist’s radar again!

http://www.optimist123.com/optimist/2009/01/the-paradox-of-the-paradox-of-thrift.html#comments

Gil January 15, 2009 at 6:00 am

Should have been “Uh Oh!” . . . :(

Dan May 7, 2009 at 12:29 am

Your neglecting to look at the relative inelasticity of prices in the short term…. they’re usually fixed for short and intermediate time periods by retailers. By increasing the speed at which changes happen, you actually increase the demand for goods and increase their production. What you’re interested in is not money, money is an intermediary bringing together a buyer and a seller. Increasing the number of buyers, and you’ll also increase the number of sellers. Where do you get off talking about thriftiness reducing interest rates below historical lows, increasing demand for capital when capital intensive industries are near irrelevant. lower interest rates will not help us through on their own with reduced consumer spending and expectations of potential growth in the pooper.

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