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Source link: http://archive.mises.org/9704/austrians-can-explain-the-boom-and-the-bust/

Austrians Can Explain the Boom and the Bust

March 30, 2009 by

In a recent debate, prominent Keynesian professor and blogger Brad DeLong claimed that the Austrian explanation of the business cycle “does not work as an intellectual enterprise.”[1]

DeLong quotes Paul Krugman who, back in December, apparently dealt the Austrian diagnosis a crushing defeat on both theoretical and empirical grounds.

In the present article, I will set the record straight. FULL ARTICLE

{ 36 comments }

William H Stoddard March 30, 2009 at 9:08 am

This may be an oversimple metaphor, but Krugman’s question strikes me as akin to asking why taking cocaine or methamphetamine doesn’t make people go to sleep just as going off them does. . . .

A.B. Hoese March 30, 2009 at 9:28 am

William,

You hit it right on the head! You need to be on drugs for what Krugman says to make sense!

lukas March 30, 2009 at 10:06 am

Now when the Federal Reserve artificially reduces interest rates below their free-market level, it sends a false message to entrepreneurs. Firms begin expanding as if consumers have increased their savings, but in fact consumers have reduced their savings (due to the lower interest rates).

But wouldn’t entrepreneurs that “got” the ABCT grow their businesses sustainably and make a killing as the contraction kills off their competition? How is it that entrepreneurs can be fooled, fooled, and fooled again by the central bank? Isn’t a market supposed to sort that out in the long term?

fundamentalist March 30, 2009 at 10:06 am

Well done! This analysis demonstrates that the data always confirms the Austrian theory if you understand the data correctly and don’t use highly aggregated data. Of course, DeLong and Krugman may be attacking the Austrian theory to deflect criticism of their own theories for their utter failure to see this crisis coming as the Austrians did.

N. Joseph Potts March 30, 2009 at 10:08 am

Krugman’s question is so stupid as to be a non sequitur.

If he hadn’t received a Nobel, it wouldn’t merit this much attention.

Magnus March 30, 2009 at 10:11 am

How is it that entrepreneurs can be fooled, fooled, and fooled again by the central bank?

1. Because the excess dollars look and function exactly like regular dollars.

2. Even an Austrian-minded business-person still needs to compete in the real world — which means competing against the companies that are taking advantage of all the easy-credit money. (It’s kind of like how Ford, even though it didn’t take the government bailout money, and is thus free, for now, from the dictates of the White House regarding the composition of its Board of Directors, Ford still needs to compete against GM. And GM is being propped up artificially.)

Nick E March 30, 2009 at 10:28 am

“How is it that entrepreneurs can be fooled, fooled, and fooled again by the central bank?”

Because what entrepreneurs really need to know is the rate of time preference of large numbers of people, and the interest rate at which banks lend money is (in the absence of the distorting effects of monetary inflation) an excellent proxy measure of exactly that. When central banks decide to try to heat up the economy for the benefit of politicians, they flood banks with paper reserves, which also reduces the bank’s risk of lending. And sends the entrepreneur an identical signal.

andy March 30, 2009 at 10:29 am

“How is it that entrepreneurs can be fooled, fooled, and fooled again by the central bank?”

Actually, many aren’t, but then the government goes on and hikes their taxes to bail out the reckless….

Some also anticipate this, and go offshore. But they like their privacy for obvious reasons, so you won’t hear too much about them…

andy March 30, 2009 at 10:34 am

“How is it that entrepreneurs can be fooled, fooled, and fooled again by the central bank?”

also another strategy is to spend some of the profits from the bubble years on political protection… it’s pretty obvious from the bailouts who’s been doing this

GunderDog March 30, 2009 at 10:36 am

This is great news. Krugman is mocking Austrian theory. That means he (and perhaps in the future the New York Times) does not feel he can just ignore it completely like it’s some kind of whacko, marginal perspective. As Schopenhauer said: “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”

Stephen Grossman March 30, 2009 at 11:20 am

Krugman’s problem is Pragmatism, the absurd claim that time is isolated instants instead of a flow from past to present to future. For Pragmatists, there is only this moment now in which there is a crisis demanding instant action. When the action is revealed in time as destructive, Pragmatists evade past experience for another isolated instant, cut off from past and future. Thus there cannot be any intertemporal capital structure, merely this moment’s emergency inflation. And when the inflation has shifted resources away from the most productive uses, Pragmatists dont regard that as the necessary future of their past inflation. Oh no! Pragmatists whisper in each others’ ears that Roosevelt would have ended the Gr. Depress. sooner if he only had more power. Pragmatists are dumber than doorknobs. Notice that _Human Action_. See Ayn Rand for a rational alternative to Pragmatism’s greasy influence on science.

Stephen Grossman March 30, 2009 at 11:27 am

From “Notice that _Human Action_.” I omitted, “has two(2) chapters on time.

Eric March 30, 2009 at 11:42 am

This Krugman-ism has always mystified me. It’s difficult to understand how someone can miss such an obvious result.

“why didn’t we need high unemployment elsewhere to get those people into the nail-pounding-in-Nevada business? “

When the bubble is growing, businesses in the bubble not only bid away other workers from other fields, they also hire marginal workers, many who are unemployed currently. If anything, there’s likely to be a relative shortage of workers in non bubble areas, NOT more workers being laid off.

After all, doesn’t the unemployment rate tend to decrease during the boom? But when the bust occurs, these marginal workers will likely be the first to go, unless of course the government intervenes.

Matt Houseward March 30, 2009 at 11:52 am

Murphy hit’s this one out of the park, but I have to say that Krugman threw him a meatball. What a terrible criticism of the ATBC. If deflation causes unemployment, why doesn’t inflation? After all, they both end in “flation”?

I would add one more point to Murphy’s response. I would surmise that Americans were able to keep pace producing goods for consumption by tapping into under-utilized global markets. Anecdotal evidence seems to suggest that we’ve moved a lot of jobs overseas during the boom years, but we never had any significant unemployment to speak of. Seems like this was one of the ways the American market adjusted to the increased competition for resources. Indians may be able to answer phones from India, and the Chinese may be able to produce widgets from China, but neither can build a home in Las Vegas. Much like the Great Depression, productivity gains were able to mask the reallocation of resources to capital markets.

Old Hop March 30, 2009 at 12:05 pm

“How is it that entrepreneurs can be fooled, fooled, and fooled again by the central bank?”

Just as new combinations of buyers and sellers constantly enter then leave markets, so it is with entrepreneurs.

Inquisitor March 30, 2009 at 1:06 pm

Is Krugman a glutton for punishment? I know DeLong is just plain stupid, so I won’t ask about him.

wilderness March 30, 2009 at 1:28 pm

“In contrast, once the bubble has popped, many firms realize they are embarked on unsustainable projects. They need to lay off their workers. Unemployment goes up, and only as workers reluctantly accept lower wages can they be reintegrated into the economy. On average, workers are earning less during the bust period than at the height of the boom. This is because the salaries and wages of the boom period were exaggerations of the true “fundamentals” of worker productivity, and also because the fundamentals themselves have been hurt due to the waste of capital during the boom period.”

I would add to this quoted paragraph from this excellent blog: Not only do wages go down for workers to be accepted back into the market, but also, why the increase in both parents needing to work in a household has increased. The value of the money has decreased so not only does “the” or ‘one’ worker have to except lower wages, but also a household needs to supply more workers to generate an income to meet market prices.

Borislav March 30, 2009 at 1:29 pm

Will bashing Krugman ever stop :-)?

Move to heavier Keynesian like Roubini.

Peter Surda March 30, 2009 at 4:22 pm

> How is it that entrepreneurs can be fooled, fooled,
> and fooled again by the central bank?
I’ll try my own interpretation on this one.

From purely empirical point of view, an entrepreneur has no way of distinguishing between prices that are inflated and prices that reflect a free market value. It might be possible in simple markets, by analysing the relationships. As the market structure grows more complex and the financial relationships between activities become less evident, so does the ability to distinguish between those two decrease. Or if you prefer the opposite way of looking at it, the distortions creep into other areas until they are basically everywhere.

So even if you know that it might be distorted, it doesn’t really help you to improve the quality of your calculations, because it is less and less clear what data is correct.

Kevin B March 30, 2009 at 5:00 pm

Stephen Grossman: “For Pragmatists, there is only this moment now in which there is a crisis demanding instant action.”

That doesn’t sound pragmatic at all. Cause and effect are often separated by moments. Isn’t wisdom the ultimate goal of pragmatism, i.e. application of limited knowledge toward the best overall living of life?

Jaycephus March 30, 2009 at 5:15 pm

Borislav: “Will bashing Krugman ever stop :-)?

Move to heavier Keynesian like Roubini.”

But who can give up a chance to prove that you’re smarter than a Nobel prize winner!! ;)

Admittedly, the novelty of such a thing has worn off now that GORE has won a Nobel prize. NOW grade-school kids are smarter than a Nobel prize winner!

Jaycephus March 30, 2009 at 5:16 pm

Borislav: “Will bashing Krugman ever stop :-)?

Move to heavier Keynesian like Roubini.”

But who can give up a chance to prove that you’re smarter than a Nobel prize winner!! ;)

Admittedly, the novelty of such a thing has worn off now that GORE has won a Nobel prize. NOW grade-school kids are smarter than a Nobel prize winner!

Jaycephus March 30, 2009 at 5:17 pm

Borislav: “Will bashing Krugman ever stop :-)?

Move to heavier Keynesian like Roubini.”

But who can give up a chance to prove that you’re smarter than a Nobel prize winner!! ;)

Admittedly, the novelty of such a thing has worn off now that GORE has won a Nobel prize. NOW grade-school kids are smarter than a Nobel prize winner!

ehmoran March 30, 2009 at 5:28 pm

“Pragmatic”, I’m really not liking that BUZZ word anymore.

It’s like a “systemically pragmatic and morally hazardous exuberance”. Instead of a BUZZ word, lets make a BUZZ phrase, since it’s all BS anyway.

This is what PRAGMATIC means:

“Socialists assert that all human actions and reactions depend upon environment. The theory is that human beings are mere robots, responding only to “external stimuli”, and that heredity and the accumulated experience of countless centuries, should be disregarded. This is part of what socialists call the “PRAGMATIC APPROACH….

Eric March 30, 2009 at 6:44 pm

> How is it that entrepreneurs can be fooled, fooled,
> and fooled again by the central bank?

Suppose your business sells something that has become more in demand because of a boom that creates more customers for your product.

You might say, “this can’t last, cause this is just the effect of the FED printing more money for my customers to spend”.

So, you have more customers, but now you don’t have enough sales people (or tech support etc.) to cover the new demand. What do you do?

First, you don’t know if the FED will keep the boom going for 10 years or just 1 year. If you don’t hire more support people, or maybe expand your warehouse, your customers might go to the competition (who let’s assume doesn’t understand what the FED is doing). They may all go broke in the next few years when the bust happens, but in the meantime, you’ve lost your customers and may go broke now.

So, even if you know what’s going on, you might have to expand to compete.

This reminds me of an old Star Trek episode where the enemy aliens seemed to have a much more powerful ship, but it turned out that they didn’t have any reserves since they were on a suicide mission. But the Enterprise still had to deal with them as though they what they appeared to be, a ship with more range.

Some of your competitors may be fooled into a suicide mission, but until they die, they will take business from you unless you compete. So, you can be forced to expand even if you are not being fooled by the central bank.

Greg Ransom March 30, 2009 at 9:03 pm

Robert — I think you’re one more who has been fooled by the assumption that Krugman is an honest and honorable man. He isn’t. What he writes is b*llsh*t in the sense explained by philosopher Harry Frankfurt in his important essay, “On Bullshit”. Krugman has no regard for the truth or the facts when it comes to the Austrian theory of the trade cycle — he’ll say whatever come to mind to discredit it, with no concern whether or not he’s explained the theory correctly or whether or not his objects have any relevance to anything.

Andrew Taranto March 30, 2009 at 9:06 pm

Didn’t DeLong ban the use of his name in connection with anything from the Mises Institute? Or something like that?

Mark March 30, 2009 at 10:25 pm

Housed depend on lumber, nails, pipes, wires, shingles and whatever else. These suppliers should have been hit by the recession right after the housing markets were hit, and they don’t necessarily exist in the same states hit the hardest by the housing bust. Also, pretty much every state was hit by the housing bust to some degree.

Kevin B March 31, 2009 at 1:12 am

ehmoran: “This is part of what socialists call the “PRAGMATIC APPROACH”

Meh, let the socialists say that capitalism is chaos and pragmatism is dogmatism, etc etc etc.

They don’t want what we have to offer anyway.

ehmoran March 31, 2009 at 1:15 am

Good point……

Evan March 31, 2009 at 1:57 am

This DeLong fellow strikes me as quite arrogant and devoid of much serious debate. Having watched the debate and seen his blog, it seems to be mostly one-liners and citations of other economists without adequate paraphrasing and support for their ideas. I wouldn’t worry about what he has to say.

Austroglide March 31, 2009 at 11:20 am

I’ve read a bit from DeLong’s blog regarding the current recession. His view seems to be that, of course, the whole thing is about “lack of confidence” and a resulting “credit crunch”, the original catalyst for which was banks’ over-leveraged positions in bad assets. From this view, Keynesian stimulus indeed appears a natural short-term solution.

I think this is part of the reason why there’s so much “talking past” each other between Austrians and Keynesians: Austrians understand the ACTUAL causal events of business cycles, and Keynesians don’t but think that they do. It’s like Plato’s allegorical cave – the Austrians are outside seeing things by the light of day, and Keynesians are merely seeing shadows on the wall, believing them to be reality all the while.

Oil Shock March 31, 2009 at 1:45 pm

I feel a little queasy when Austrians start using stats like unemployment, we might fall in to the trap of using the same “lies, damn lies and statistics” that other camps use to propagate their lies.

Stephen Grossman April 1, 2009 at 9:20 am

Pragmatism is the unprincipled, short-range, pseudo-practicality of drug addicts, prostitutes and dictators. Pragmatism is the rejection of absolutes and systematic reasoning. Pragmatism is arbitrary experimentation. Pragmatism is cynical idealism and idealism is an evasion of realism. Pragmatism is giving socialism one more chance because its past failures were different in some psychotically tiny way.

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