Dear Professor Becker:
I was pleasantly surprised to see you seriously entertain the notion that “depressions”–for younger readers, the term economists used to use for what we now call “recessions”–might serve a socially useful function. This is a crucial issue, as the government has already committed more than one trillion dollars, and assumed incredible powers, in an attempt to skirt the current slump. Virtually every financial commentator takes it for granted that boom periods are good while recessions are bad, and that government policies ought to foster booms while minimizing recessionary periods. FULL ARTICLE
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Very good!
The difference between overinvestment and malinvestment is the key that quantitative models simply don’t envisage.
Once grasped, it’s difficult to take supply-siders or keynesians seriously…
A good “Open Letter”.
Now we will see if Professor Becker will reply, if he does reply he will prove himself superior (as a man) to certain other people. Namely Paul Krugman and the other Keynesians who tend to react to a critical examination of their works by simply igoring the points made.
I liked the piece very much but I have one reservation concerning the difference between recession and depression. I think there is a real difference, and that while recessions are good real depressions are not and are better avoided. The present situation is no real depression – like the Great Depression – e.g. we have no massive contraction of the quantity of money for instance. If this were to happen it would be better to avoid it. It should be possible, however, to liquidate the malinvestments while avoiding a real depression.
Austrian School Vs. Chicago School…
It’s about time the Austrians, became more aggressive and attacked this school, especially during our turbulent times. Academia, the public, and politicians need to be guided in the right direction if we want a way out of this Depression.
God bless Dr. Murphy!! The fallacies expounded by the Krugmanites, Keynesianites, and Friedmanites should be exposed for all to see.
All good and well; still we have no depression… as no Monetarist would fail to acknowledge…
Note that this point is better acknowledged from an Austrian viewpoint too; the idea that we have a depression can only strengthen the incentives of those who want to pump money in the economy…
This was an excellent engagement. This crises is a real chance for teaching real economics and Mises Inst. I hope this types of engagements continues.
It shouldn’t be only Ron Paul and Peter Schiff doing the representing. Maybe they can mention some names associated with the Inst. so that others can get some air time.
There is one factor present today that did not exist in the past which impact the depth of an ecnomic downturn. That is JIT inventory system and the technology that is in place. Most businesses have only 2 weeks inventory of supplies on hand to meet their current demand which means if demand for finished goods fall, they will still burn through their current supplies in less than a month. Unlike the late 70′s where inflation caused manufacturers to stockpile supplies that could carry them for 6 months or more.
Another factor present today is a 24 hour news media that reports news without verification. This media exposure has moved markets instantly and wild swings as investors move on every bit of speculation.
I am totally against all the bailouts and stimulus packages as they are counterproductive. But I am going to watch Obama come on board with interest as the media has a love affair going with him and just see if the economy turns on how the public reacts to him. My opinion is the economy is going to turn and Obama will get credit for it even though he had nothing to do with it.
Hats off to Robert Murphy for bringing clarity to a complex situation. It is difficult to respect the main stream economists when one realizes that they too the same opportunity that we have to understand these things.
This could well have been an open letter to a number of economists. I have yet to read a critique of Austrian economics wherein the critic actually understood the Misesian theory of the business cycle.
Is it just me, or do the “free market” monetarists begin to sound more and more Keynesian as this crisis progresses?
Publius99,
There is a great incentive to say that something needs to be done, for by doing so, you then raise the stock in your own opinion and abilities. Those who recommend a Laissez-Faire approach are often ridiculed for being heartless or in the pockets of big business. It is this combination which proves to be such a siren song, calling from the Keynesian waters, leading those free market economists who do not have a strong foundation to flounder and reject the free and the market adjectives in front of their title.
Publius99:
But the problem is that one cannot pursue a truly Laissez-Faire approach within the prevailing institutional context, with central banks etc.
Either you allow individuals to produce their own money, have their own banks etc. – which presupposes abolishing central banks etc. – and then you can have a truly Laissez-Faire policy, or else you keep the system in existence but then the best you can hope for is “mimicking” Laissez-Faire, not true Laissez-Faire. It is not a matter of lacking a strong foundation, it is a matter of some Austrian economists oversymplifying matters…
Peter van Haaren
“I liked the piece very much but I have one reservation concerning the difference between recession and depression. I think there is a real difference, and that while recessions are good real depressions are not and are better avoided.”
Recessions are good? Oh Yeh? I have been out of work many times in past “recessions” and they felt like “depressions” to me. I would say that anyone out of work not of their own volition is in a “depression”.
These are terms created by collectivist governments to mislead the populace into thinking that the problem is not of governments’ making but in their power to solve.
Unfortunately governments solve nothing but make the problems worse to be overcome later.
It took the Soviet Union 70 years to dissolve, it seems most Politicians and those that vote for them have learned nothing.
This article did a great job in explaining that..
Matt:
Have you read Bob´s article? I think he was trying to explain to Gary Becker in what sense recessions are indeed good, namely because they liquidate the malinvestments etc.
I think what we have is indeed a real insolvency problem; the free market solution to that is indeed letting them fail.
But while there have been several recessions, we have had no real depressions since WW II.
So perhaps Bob should have started his article “The is some disagreement whether this is a real depression, but supposing there is etc…”
It´s not “terms created by governments to mislead” etc. Stop bullshitting… It´s a matter of technical economics…
Excellent letter! Clear, concise, and informative.
I like the poison analogy. My favorite to use is drug addiction. The addict (the electorate) is addicted to a drug (easy money), and the dealer (the government) keeps supplying it in order to keep the addict’s business (votes).
The longer the addict keeps taking the drug, the worse the withdrawal symptoms (recessions) when he tries to kick the habit. If the addict cannot beat his addiction, his quality of life plummets and eventually the drug results in his death (economic collapse, Zimbabwe style).
To stretch the analogy a bit, one could view believers in free markets as the annoying friend who tries to help the addict but instead is blamed by the addict for all of his problems.
“Government efforts to stymie this necessary readjustment simply ensure that the band-aid is pulled off verrrrry slowly”.
I wish people wouldn’t use this illustration. People differ in how they feel pain, and I learned as a child that I personally felt less pain if they were pulled off slowly, because I wasn’t taken by surprise and could focus – yet, over and over, I was hurt unnecessarily by a succession of adults who were convinced that they knew better than me what hurt me. At least this sort of thing stopped once I grew up – apart from one nurse when I was giving blood, who stabbed me with a needle to draw a drop for testing while I was talking, ignoring what I had said that, for me, that wasn’t a distraction that reduced discomfort but instead prevented me from applying the concentration that – for me – reduces discomfort. Damned fool “professionals”; why encourage them in this one size fits all stuff?
Of course government needs to do something–it needs to stop trying to “fix” the economy! Furthermore, it needs to undo the damage it’s already done in the past.
What a great way to explain the difference between overinvestment and malinvestment.
Friends think I am crazy for wanting to stockpile food right now. They cannot seem to accept a severe downturn is inevitable.
Thanks for the nice response. That tarp covering the lack of bricks suspiciously sounds like the Fed’s T.A.R.P. So, what’s really under the Fed’s tarp maybe a bunch of broken bricks.
I doubt very much that individuals like Becker and Posner do not understand the Austrian theory of the business cycle, which is not too difficult to grasp after all. My guess is that they are faking their misapprehension of the theory, either because they do not believe the theory to be logically compelling, or because they do not think it is empirically relevant.
Aloïs,
Or more likely, because it and the principles from which the business cycle theory is based indicate that there is no need for court economists of the type that they are accustomed to being. It is simply a matter of job preservation.
Ah, but when the Fed finds out we are short bricks, they just print, I mean lend, us money to buy more bricks to keep on building. The tarp is still hiding the true shortfall in the U.S.
A Keynsian might say, money is not like bricks we can just print more “bricks” and finish the house as originally (but mistakenly) planned. But in the house analogy what the Keynesians are doing are just cutting the bricks in half and saying, “see, now there are twice as many bricks!” It’s still the same inadequate amount of material.
Stanley:
There is undeniably a demand for court economists. They are more numerous and often better paid than Austrian economists.
” This could well have been an open letter to a number of economists. I have yet to read a critique of Austrian economics wherein the critic actually understood the Misesian theory of the business cycle.
Is it just me, or do the “free market” monetarists begin to sound more and more Keynesian as this crisis progresses”
You have to remember that economics as a science sold its soul (ie. ability to tell the truth) long ago to politicians and bureaucrats.
The nation-state we have now needs technocrats who can develop policies that in the short run get those in power positions re-elected, regardless of how destructive their long run consequences are.
A good post, but like many articles on ABCT, there are a few things that bug me:
Obviously, no honest person can deny that the scraping of bad investments and business plans is costly and timely. After a cluster of malinvestments in housing (which we obviously had), the economy cannot simply do an about-face and go back to its previous level of productivity on the spot. Any notion that stimulating aggregate demand is all that needs to be done to avert a recession should be laughed at, in my opinion.
However, this does not mean that the liquidation of bad business plans is the only cause of the current recession, or that monetary policy is the major cause of the malinvestments (undoubtedly, there were other contributing causes). But I think the first point is the most important, since we are talking about recovery: Might we be able to soften the coming recession, because some of the downturn in productivity is not caused by malinvestments?
Both Austrians and Keynesians have stressed the non-neutrality of money. Keynesians show how sticky prices mean that markets do not adjust to deflation instantly, and Austrians show how economic calculation is distorted by changes in the money supply. Austrians agree with Keynesians that monetary deflation is bad and should be avoided (they disagree on productivity-fueled deflation, but that isn’t what we are dealing with here).
If the Fed and the government did nothing, we’d undoubtedly experience monetary deflation (if we aren’t already). Free banking theorists seem to believe that under their proposed system, banks would adjust the money supply to meet the demand for money on their own, obviously without government interference. However, we are most certainly not operating under a free-banking environment! Given that we are living in a system where the government effectively owns and designs the banking system, should the government really do nothing? Shouldn’t we consider that a better course of action might be for the Fed to try to emulate a free banking environment to the best of its ability?
Austrians seem to assert, perhaps implicitly, that ABCT explains most or all recessions. However I do not believe this to be supported by ABCT itself. Showing that A causes X does not mean that B, C or D cannot also cause X.
grant says:
“Austrians agree with Keynesians that monetary deflation is bad and should be avoided…”
this is incorrect. within the austrian congregation there’s no unanimity on this point. i recommend you read:
http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf
and also hulsmann’s “deflation and liberty” (pdf in “literature”).
Grant: “Austrians seem to assert, perhaps implicitly, that ABCT explains most or all recessions. However I do not believe this to be supported by ABCT itself. Showing that A causes X does not mean that B, C or D cannot also cause X.”
Austrians recognize that crop failures, wars, new technologies, natural disasters and other things can cause fluctuations in business activities. But these events are already understood by everyone. They need no explaining. The ABCT explains the major, regular fluctuations that have mystified people for centuries. It goes back at least to Cantillon in the early 18th century. Cantillon was Menger’s inspiration from what I understand.
The ABCT does have a single cause–manipulation of money–but it also has secondary effects, such as deflation. Most Austrians have argued that you should let deflation run its course, but some have argued for using inflation to stop it. The argument against re-inflation is that it does not stop the depression; it just postpones its. I think Japan of the 1990′s is a very good argument against stopping the deflation. They endured a decade long depression as a result.
The essential problem of the depression is that monetary manipulation caused the structure of production (capital goods versus consumer goods) to get out of proportion to the desire of consumers. Monetary inflations causes industry to producer more capital goods and fewer consumer goods than consumers want. Re-inflation does nothing but cause consumers to demand even more consumer goods that arent’ available yet. That causes price distortions and re-ignites the business cycle for a short while and cause more bad investments.
There really is nothing that can be done using money. The structure of production must be re-aligned and resources re-allocated to comply with consumer demand. That’s a very painful process, but any attempt to speed it up or prevent it is only more painful.
The choice isn’t between a painful adjustment and a painless one, as most mainstream economists think. It’s between less pain now (the Austrian solution) or greater pain later (the mainstream solution) as the Japanese discovered.
Grant,
you are proposing the opposite of what Mises and Hayek recommend. They argue against reflation and counter-cyclical policy. By preventing the deflation which comes about as the fractional reserve banks deleverage, you prevent the liquidation of the malinvestment. You basically increase the amount of overproduction for the the start of the next business cycle and in so doing, only achieve a slightly lower rise in capital goods prices at the beginning, but you never the less, sow the seeds for this new cycle with a monetary policy which prevents the matching of true saving to investment.
It is true that mises was against deflation as a monetary policy (particularly in light of the terrible consequences for Britain after WWI as they tried to deflate to prewar gold standard parity), but he was more emphatically against the policy that you propose, for this is the impetus in the theory of the business cycle. All attempts at maintaining price stability only obtain an increasing amount of malinvestment, whether this is implemented during a boom or bust period of the business cycle.
If the central bank wanted to emulate anything, it should attempt to emulate a 100% reserve free banking system, eschewing all open market operations. In this situation, the ability to migrate the system to free banking is most easily implemented. Under this system, despite the unceasing siren calls for demagogues to take the reins of the central bank, there would be no monetary policy caused business cycle. Furthermore, the inflation and deflation which are endemic to fractional reserve banking would be eliminated as well as the wealth transfer that these phenomena entail.
bagus’ paper (http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf) compares the differing views on deflation of hayek, mises, reisman and rothbard.
his exposition shows the inconsistencies of these luminaries in the area of deflation. bagus is a student of hulsmann, who’s filled in some of the lacunae in this area.
are you there, dick fox?
newson, thanks for the links. I’m reading Bagus’ paper.
fundamentalist, the argument for re-inflating or stopping deflation isn’t that it stops assets from being liquidated, but that it prevents the harmful effects of deflation on the rest of the (sound) economy. Deflation, like inflation, causes prices, wages, loans and contracts to be re-set, re-negotiated or defaulted on across the economy (inflation of course causes the same, but deflationary crunches tends to occur more quickly). As a result, sound business plans can fail for reasons that have nothing to do with the structure of production. I guess you could delay the recession if you somehow caused the housing bubble to go on longer, but I don’t believe that is what anyone is proposing central or free banking should do.
Austrians who argue for free banking and then argue that central banks should do nothing confuse me. Under free banking, the banking system would most certainly behave differently during recessions than it does during growth periods. As a political monopoly, the central bank of course cannot exactly emulate the behavior of a multitude of free banks, but it can at least try. The Fed, of course, cannot simply abolish itself or the multitude of banking regulations, and so I don’t see any benefit from it doing nothing.
Grant: “…the argument for re-inflating or stopping deflation isn’t that it stops assets from being liquidated, but that it prevents the harmful effects of deflation on the rest of the (sound) economy.â€
All business plans are sound when they are made. That’s the problem with the artificial boom. It lures everyone in and doesn’t tell anyone which business plans will become unsound. Which plans are unsound only becomes apparent with the bust. Through no fault of their own, they happen to invest in the wrong sectors. It may be a tautology, but the plans that are unsound are the ones that go bust. If they’re sound, they won’t go bust, but you can only know the sound ones after the downward spiral ends. However, if a business person learned Austrian econ and expected the cycle, he would keep debt levels low just in case his business got caught in the whirlpool. Low debt levels make survival much more likely. It’s not totally random.
Those unsound ones must be liquidated and their assets reallocated for new growth to start again. Capital producing industries must become re-aligned with consumer demands. There is no other way. That requires liquidation and reallocation. Re-inflating may not be intended to stop the process of liquidation, but it can and usually does.
As for free banking, Mises thought that it would prevent artificial booms because each bank would act as a check on other banks to keep them from inflating the money supply. Free banking would not be better during a depression, but it should prevent, or at least dampen, unsustainable booms which lead to depressions.
Grant,
free banking with fractional reserves, or central banking + fractional reserves guarantee that there will be monetary contraction during the bust. The only way to avoid this monetary deflation would be to demand a 100% reserve on all demand deposits and alike accounts.
On a side note, even central bank operating with 100% reserves which engaged in open market operations could stimulate a business cycle if it purchased securities. As such, the only way to avoid business cycles and monetary inflation and deflation is through a 100% reserve free banking system.
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