http://diaryofarepublicanhater.blogspot.com/2013/04/what-causes-business-cycle-sumner-vs.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+DiaryOfARepublicanHater+%28Diary+of+a+Republican+Hater%29
What struck me is the large contrast between these two theories. Sumner sees nominal causes as essentially the sole causes of the business cycle, while ABCT sees it quite differently: basically as malinvestment.
Here again is Sumner:
"I’ve been thinking about how to teach monetary economics from the beginning. Perhaps before people start learning, they need to unlearn things they believe, that just ain’t so. We market monetarists believe that monetary shocks (or “disequilibrium” if you prefer) is the primary cause of business cycles, indeed almost the only cause of big swings in unemployment."
"Most people don’t believe this; indeed it’s not even clear that most economists believe this. Instead the average person thinks recessions are caused by big real shocks, or financial shocks, of one sort or another. Asset bubbles bursting, 9/11, stock market crashes, devastating natural disasters, etc."
Here was Haberler, years ago on ABCT's "more refined" explanation of the business cycle:
"The traditional monetary theory, which is represented by such well-known writers as the Swedish economist Professor Cassel and Mr. Hawtrey of the English treasury, regards the upward and the downward swing of the business cycle as a replica of a simple government inflation or deflation. To be sure, it is--as a rule--a much milder form of inflation or deflation, but at the root it is exactly the same. Mr. Hawtrey states this quite uncompromisingly in his famous dictum: "The trade cycle is a purely monetary phenomenon" and is, in principle, the same as the inflation during the war and the deflation, that is to say, the reduction of the amount of circulating medium, which was deliberately undertaken by certain governments to approach or to restore the post-war parity of their currencies."
"Let me now indicate briefly why this explanation seems to me insufficient. Or, to put it in other words, I shall try to show that (a) the price level is frequently a misleading guide to monetary policy and that its stability is no sufficient safeguard against crises and depressions, because (b) a credit expansion has a much deeper and more fundamental influence on the whole economy, especially on the structure of production, than that expressed in the mere change of the price level."
Clearly this is a "real"-not a nominal explanation for the business cycle. Lars today argued that ABCT is therefore a supply side explanation-though Austrians often don't like to talk in terms of AS/AD:
"What people often fail to realize is that the Austrian business cycle theory basically is a supply side story."
He's in line with what I've been thinking-of course, neither he or I are Austrians and many of them won't like this Lars then explains the ABCT idea of "relative inflation"-and "relative deflation" pretty well I think. ABCT doesn't actually necessarily claim that the boom is characterized by "galloping inflation" overall, but that certain prices in certain industries likely will be elevated. Essentially, because the Fed's low interest rates lead investors to wrongly think the Wicksellian interest rate is very low, they invest in the wrong things-too much in "roundabout" production industries that take more time to complete. They insist that it's not so much an "overinvestment" as a "malinvestment."
We can see examples of this during the housing boom there wasn't a generally high inflation but there was a high relative inflation in the housing market. Then in 2008 there was relative inflation in oil and commodities-which lead to a slightly higher inflation rate overall.
Lars points out that if this were a supply side shock, though, we should see a rise in inflation during the bust and that this shouldn't be seen as a problem:
"And this brings me to what I really wanted to say. An increase in inflation should be welcomed if it reflects a rational and undistorted reaction to investors realising that they have made a mistake. That is exactly what happens in an Austrian style bust. We might get relative deflation/disinflation, but the aggregate price level increases due to the negative supply shock."
"I have been thinking about an issue that puzzles me – it is about inflation in an Austrian School style bust."
"Here is the story. If we think about a stylized Austrian school boom-bust then the story more or less is that easy money leads to an unsustainable boom that eventually – for some reason – will lead to a bust."
"What people often fail to realize is that the Austrian business cycle theory basically is a supply side story."
He's in line with what I've been thinking-of course, neither he or I are Austrians and many of them won't like this Lars then explains the ABCT idea of "relative inflation"-and "relative deflation" pretty well I think. ABCT doesn't actually necessarily claim that the boom is characterized by "galloping inflation" overall, but that certain prices in certain industries likely will be elevated. Essentially, because the Fed's low interest rates lead investors to wrongly think the Wicksellian interest rate is very low, they invest in the wrong things-too much in "roundabout" production industries that take more time to complete. They insist that it's not so much an "overinvestment" as a "malinvestment."
We can see examples of this during the housing boom there wasn't a generally high inflation but there was a high relative inflation in the housing market. Then in 2008 there was relative inflation in oil and commodities-which lead to a slightly higher inflation rate overall.
Lars points out that if this were a supply side shock, though, we should see a rise in inflation during the bust and that this shouldn't be seen as a problem:
"And this brings me to what I really wanted to say. An increase in inflation should be welcomed if it reflects a rational and undistorted reaction to investors realising that they have made a mistake. That is exactly what happens in an Austrian style bust. We might get relative deflation/disinflation, but the aggregate price level increases due to the negative supply shock."
"Therefore, when Austrians often argue that the bust should be allowed to play out without any interference from the government or the central bank then that logically mean that they should welcome an increase in inflation in the bust phase of the business cycle. That obvious is not that same saying that monetary policy should be eased in the bust phase, but inflation should nonetheless be allowed to increase as we get “benign” inflation."
"However, in my view that would mean that it would be wrong from an Austrian perspective for the central bank to tighten monetary policy in response to rise in (supply) inflation during the bust. Those Austrian economists who favour NGDP level targeting – like Anthony Evans and Steve Horwitz – would likely agree, but what about the “internet Austrian”? And what about Bob Murphy or Joe Salerno?"
Woj as our resident Austrian any thoughts? To be sure Woj is not at all a typical Austrian as his analysis combines ABCT with Post Keynesianism. In the comments section, some Austrian commentators disagreed with Lars-it's not so much a story of increased A/S as a new composition of it. Of course wouldn't this make it a "relative supply shock?"
Another commentator left a link for Lars that argues that ABCT is actually a demand side story of the business cycle. I will read it as soon as I post this. Before even looking at it, though, I guess ABCT is a nominal story to the extent that it's the Fed's cutting rates that leads to the trouble leading to overinvestment in the wrong industries.
Sorry for the delay in commenting but life is busy these days (hence why my own posting has been on hiatus). Anyways, some quick thoughts since this topic relates to discussion in my class last night...
ReplyDeleteHabeler's interpretation of ABCT refers to an economy that is always on its PPF (i.e. in equilibrium). In this case the economy merely shifts between investment and consumption, so relative prices change and result in malinvestment but there is no rise in the price level. Furthermore, there is really no boom, only a resulting bust.
Garrison's version of ABCT (the more modern version which builds on Hayek) allows for the economy to move beyond the PPF. This adds a demand side story whereby consumption and investment expand beyond sustainable levels initially due to over-expansion of credit. When interest rates eventually rise to reflect the "natural rate", many longer-term investments are recognized as no longer profitable, which causes investment to slump (there is also an assumption that investment is negatively correlated with interest rates). During the bust it is possible that consumer prices would rise since there was under production of consumer goods during the boom. Producer prices, however, would decline. The overall effect on the price level isn't clear.
It should be noted that Hayek was in favor of stabilizing nominal income (NGDP), so it is incorrect to say that Austrians believe the government/Fed should do nothing. Not stabilizing NGDP can lead to a secondary deflation in Garrison's story.
Separately, it should be pointed out that much of this analysis presumed some sort of gold standard. Furthermore, it assumed that interest rates were endogenous and the supply of money exogenous (entirely unlike the monetary regime today). Therefore an increase in the money supply caused the interest to decline initially and a subsequent decrease in the money supply would have brought interest rates back to the natural rate. Since the money supply would be largely unchanged, but money demand would increase due to declining NGDP, the price level should be falling (unlike the suggestion by Lars).
Last comment, it is worth noting that in The Theory of Money and Credit, Mises generally refers to a fiat money system...which leads him discuss the cycle based on the expansion of bank credit (breaking with monetarist tradition).
Hope that helps clear up some questions rather than adding more to the list.
Thanks Joshua! I'd say it does provide some clarity. Of course there is some major fissures between different strands of Austrianism: the Rothbardian wing is absoultely opposed to NGDP targeting, Hayek as you mentinoed was sometimes for it-though not when it might have really counted in the early 30s.
ReplyDeleteI find that some of what Lars wrote was thought provoking-he had another post that I will write about soon
http://marketmonetarist.com/2013/04/09/spains-quasi-depression-an-austrian-bust-or-a-monetary-contraction-or-both/
I think I'm finally getting what Austrians mean by things like "relative inflation" or "relative deflation"; I had previously thought it was just pure causitry.
You know, it seemed an Austrian promised galloping inflation it didn't happen so next he said "well I was right as there was lots of 'relative inflation'so when are you going to admit it?"
You have to remember-much of my early exposre to Austrianism was the very basderized ramblings of Major Freedom-an extremely dogmatic and unpleasant Rothbardian.
I find that when you do talk about "realtive inflation" it does describe some stylized facts of the economy. Like during the housing boom there is meaning_i'm starting to think-in saying that it was "relative inflation" ie, inlfation witin the housing market and certain other asset prices.
Similarly we had "relative inflation" just before the bust in 2008 where oil and other commodities went through the roof the first half of the year.
So I'm thinking there may be somethig useful in it after all. To talk about "relative inflation" describes the fact that many Americans are actually seeing their incomes drop thanks to the rise in oil and other asset prices.
That link above of Lars' second piece is very interesting as he quotes from Steve Horrowitz who argues that ABCT is basically a theory of booms or boom-bust but has relatively little to tell us about what to do after the bust-ie, ABCT is not a theory of depressions.
"Both critics and adherents of the ABCT misunderstand it if they think it is some sort of comprehensive theory of the boom, breaking point, and length/depth of the bust. It isn’t. As Roger Garrison has long insisted, the theory by itself is a theory of the unsustainable boom. It is a theory that explains why driving the market rate of interest below the natural rate through expansionary monetary policy produces a boom that contains endogenous processes that will cause that boom to turn to a bust. Again, it’s a theory of the unsustainable boom."
… "The ABCT cannot explain the entirety of the Great Depression. It simply can’t. And adherents of theory who make the claim that it can are not doing the theory any favors. What ABCT can explain (at least potentially, if the data support it) is why there was a recession at all in 1929. It argues that it was the result of an unsustainable boom initiated by an excess supply of money at some point in the 1920s. Yes, the bigger the boom, cet. par., the worse the bust, but even that doesn’t tell us much. Once the turning point is reached, there’s not a lot that ABCT can say other than to let the healing process unfold unimpeded."
When talking in relative terms, some economists may argue that the term inflation is inappropriate. Regardless of that fact, in the real world, relative prices of goods/assets are clearly influenced by both fiscal and monetary policy. While this may or may not alter the long-run growth/employment paths (I clearly believe it does), the change in relative prices will definitely alter the distribution of income/wealth. Sumner presumably thinks the effects on distribution are minimal, however I don't find that argument particularly convincing.
DeleteIt is correct that ABCT is primarily a theory of the boom, which leads to a bust, but not what happens during the bust. The premise of a credit expansion pushing consumption and investment beyond a sustainable path is also perfectly reasonable, although the theory has not adjusted for the changes in monetary regimes since the 1930's. Similar to Monetarism it relies on the quantity theory of money, which no longer accurately describes the current monetary regime. This is why both groups have/continue to expect high inflation based on the expansion of the base money supply. Witnessing low inflation for the past few years, some within these groups have, ex post, come up with reasons for the absence of inflation (e.g. IOR). What they fail to realize is that even without IOR, or slightly higher capital reqs, banks would not be extending significant amounts of loans because credit-worthy demand is simply not there.
IMO, the current outlook for developed countries includes further disinflation spanning the next several years. Fiscal deficits are shrinking while the private sector remains in a balance sheet recession. QE may boost stock prices through higher P/E ratios, but it has failed to generate higher NGDP on its own.