An ad hoc sticky interest rate theory of recent recessions
The title doesn’t sound very promising. “Ad hoc” is supposed to be bad and interest rates are not sticky.
But ad hoc doesn’t actually mean bad, at least not all the time, And the fed funds target might well be sticky, even if market rates are flexible.
In my “magnetic hill” post I suggested an ad hoc theory of the last three busienss cycles. Long term real rates have trended steadily downward since 1983, and the Fed did not realize this was occurring in real time. Hence they cut rates too slowly in recessions, and the recoveries tended to be slower than normal. On the other hand the Taylor Principle did do a good job of stablizing inflation and NGDP growth. So the recessions were mild—recall that unemployment peaked at only 6.3% in the 2001 recession (actually in the recovery.)
Evan Soltas has a very thoughtful new post that comes at this issue from a different perspective, but dovetails nicely with my theory. You should read the whole thing, but I’ll provide an extensive quotation on interest rates, investment and the business cycle. I won’t comment, I’d be interested in what others think. Do these two theories fit together?
It’s possible that an investment has a positive net present value at a certain interest rate (a low one), but has a negative net present value at another, higher rate. So if all else is equal, Summers is right: If the central bank holds interest rates artificially low, it can in fact induce malinvestment — the central bank is creating an incentive to invest in projects which have negative net present values at normal interest rates. If the cost of capital was to fall below the internal rate of return, then that may generate a misallocation of resources.
That’s a bad thing, and it’s not “Austrian” to fear that. Nor is it the irrational response of a private sector to malinvest under those conditions. (I’ll concede that the Austrian version, in which the malinvestment theory leads to eventually higher inflation, higher interest rates and a vicious bust, relies on a wildly implausible assumption of basically zero rational expectations — a collective delusion. But this isn’t my concern, though Summers seems to be saying as much.)
But all else isn’t equal, and I’ve been meaning to point out this error for a very, very long time to others. So here’s the thing about recessions: They reduce businesses revenue. They do so for the short run, and perhaps the medium run. That, by definition, reduces internal rates of return across prospective investments. If expected future revenues fall and the central bank doesn’t adjust the interest rate, in other words, it’s misallocating resources, but just in a different way.
This isn’t an idle fear. I’ve sung a lonely chorus for a year or so now arguing that economic commentators have underappreciated the role of expectations. (See here and here and here.) As I document in the last link, investment volatility now explains 77 percent of all volatility in GDP over the last decade, as compared to 47 percent from 1950 to 1960. Our recessions are increasingly about shocks to expectations of future revenues — they’re not about downward shocks to consumption. So many people just don’t get this.
This evidence suggests Summers has this backwards. Recessions appear to be about internal rates of return dropping suddenly below the cost of capital, and everyone trying to exit their investment and deleverage at the same time. I also present expectations data in those links. If you think about a roster of investments ranked in order of their internal rates of return, recessions seem to create a sudden jump in how many of those investments would be “underwater.”
Here’s a simple example. Suppose that you’re starting a business. It requires a $10,000 upfront investment in the first year. You’ll make no revenue then, either. Then you expect it to bring in $1,000 in positive cash flow for the next 29 years. That’s an 8.4 percent internal rate of return.
But, woah, here comes the recession! Now you’re expecting the first three years that had positive cash flow to be zero instead. Now the net present value, at the current rate, is -$2,475. Yikes! You’ll liquidate the investment rather than take a loss like that. Trouble is, if everyone does this, it’s a problem. So the central bank should cut the cost of capital from 8.4 percent to 6.4 percent. (And had it made clear it would have done this in the beginning, none of this would have happened in the first place.)
Further evidence that this is what happens in recessions, and that an NPV-related malinvestment is nothing to worry about, comes from the fact that businesses founded during recessions are more likely to last and be successful. It implies a past discrimination towards higher-NPV ones during recessions, not negative ones. (I don’t have the data in front of me on this; I remember seeing it in a Kauffman Foundation report.)
The central bank’s solution, of course, is to bring down the cost of capital when net present value falls due to fears of weak future demand. Stabilizing that, so that entrepreneurs can know the sign of the net present value of a prospective business regardless of the point in the business cycle, is really the way you need to think about monetary policy. It’s how you kill the business cycle — by making investment more insensitive, and less of John Hicks’ “flighty bird.”
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27. July 2013 at 13:07
Evan touches on something that is very important and misundersood.
Consumption does not drive the business cycle.
But consumption is 70% of AD! Yah, so what? The variability of consumption is tiny. It rises and falls a couple of percent. Now a couple of percent of 70% is still a couple of percent of the aggregate and isn’t exactly trival. But, investment demand increases rises and falls by 25%. The net swings in investement outweigh the swings in consumption.
Furthermore swings in investement demand lead. Businesses cut back on investement first. Then AD falls, unemployent rises and consumption demand falls. Investment demand is the nose of the of the dog. It may be smaller than the body of the dog, but where the nose goes the body follows.
Now people look to the government to direct the economy. But this is excactly backward. The government is entirely reacive. The government goes where the economy takes it. The goverment is the tail of this dog.
27. July 2013 at 13:58
This kind of “magnetic hill” secular trend effect appears in the quantity theory model I’ve been working on (funnily enough, it appears as approaching the crest of a hill in a 3D NGDP-Monetary Base-Price level space). Monetary policy has been drifting towards a region where the NGDP effect of expansionary monetary policy is getting smaller and smaller. The Fed would have to be more and more expansionary to get the same effect — and with interest rate targeting, that should lead to a steady decline in interest rates.
http://informationtransfereconomics.blogspot.com/2013/07/fiscal-and-monetary-stimulus.html
The gist of it is that perturbations of NGDP and the MB have been more co-linear in the past, both moving the economy in the same direction. Now, they are almost orthogonal with perturbations of the monetary base having less of a projection along perturbations in NGDP. (The graph at the link above helps visualize this.)
Actually, several (randomly selected) countries are also approaching this location, with the US, EU and Japan having reached crest.
http://informationtransfereconomics.blogspot.com/2013/07/universalizing-model-kappa-sigma-space.html
27. July 2013 at 14:07
Evan is spot on. Tight policy (or policy extremes) creates malinvestment, and thus far the solution has been to fund further malinvestment by keeping tight money on and crushing NGDP.
Real and nominal rates were crushed and intentionally lowered in order to keep the malinvestment as a going concern.
The Fed is hostage to the wave defaulting malinvestment: hence ongoing tight policy, low yields, and low NGDP.
27. July 2013 at 14:30
“It’s possible that an investment has a positive net present value at a certain interest rate (a low one), but has a negative net present value at another, higher rate. So if all else is equal, Summers is right: If the central bank holds interest rates artificially low, it can in fact induce malinvestment “” the central bank is creating an incentive to invest in projects which have negative net present values at normal interest rates. If the cost of capital was to fall below the internal rate of return, then that may generate a misallocation of resources.”
“That’s a bad thing, and it’s not “Austrian” to fear that.
Uh, yes it is.
“I’ll concede that the Austrian version, in which the malinvestment theory leads to eventually higher inflation, higher interest rates and a vicious bust, relies on a wildly implausible assumption of basically zero rational expectations “” a collective delusion. But this isn’t my concern, though Summers seems to be saying as much.”
This is incorrect. The Austrian theory does not hold that malinvestment “eventually leads to higher inflation”, and it also does not rely on “zero rational expectations.”
For the “eventually higher inflation” assertion, the reason that is wrong is because the inflation is actually associated with the boom, not the bust. Now this is not to say that during the boom, consumer prices, or even prices in general, have to rise over time. By “inflation” it is meant inflation of the money supply, which may or may not be associated with higher prices. It will depend on future cash preference, as well as supply. Austrian theory makes no claim that after a period of malkinvestment, prices must eventually trend higher.
The key component of Austrian theory is economic calculation. This calculation is distorted by non-market money. Whether or not prices rise or fall over time, or whether or not interest rates rise or fall over time is actually besides the point. Business cycles can be generated in a context of central bank activity, with any combination of price trends or interest rate trends in the temporal sense, that is, observing over the course of history a rising or falling or stable empirical price level and/or interest rates.
This is especially important in understanding the boom bust cycle of the 1920s and 1930s. As Austrians have painstakingly pointed out for literally decades, just because consumer prices trended stable over time throughout the 1920s, it does not mean that a boom was not being generated by “loose money.” I’ll quote Sumner here and say “never reason from a price change.”
If a free market in money with no distortions to the monetary system would have generated a downward trend in prices during the 1920s, then a decade of actual stable prices represents a cponsequence of easy money, other consequences of which includes unsustainable booms and malinvestment.
Regarding the “zero rational expectations” assertion, regardless of whether Soltas finds it “implausible” has no bearing on the actual cause and effect process that really results from central banks jamming the signal of interest rates.
The question he’s touching on is this: “Is it really plausible to assume that investors can be constantly misled, over and over, regardless of how many times a boom bust cycle occurs? Why don’t they eventually learn?
Soltas, like most who believe this is a strong criticism, fails to realize that even if investors did learn, and even if they attempted to act as such, that very learning, that very “innovated activity”, will become a part of history that the central bank then has to face, and since the central banks target certain variables, the central bank will actually change the extent of its activity in order to bring about the same target outcome as before, when it required less due to investors having a less evolved information set.
For example, if a central bank constantly printed $100 million a month, and that’s it, then if there is a boom, and hence bust, that is brought about by this, then as the cycle moves forward, that $100 million a month will have less and less “effect” over time in terms of “stimulating employment” and what have you. Prices would eventually start falling as productivity rises sufficiently. Remember, we’re assuming $100 million a month, every month.
But should the central bank target unemployment, or prices, then it is going to have to increase that $100 million a month to say $200 million a month at some point, in order to bring about the same effect that $100 million used to have. This is a result of investors “learning” from $100 million a month in the division of labor and price system. That learning will take the visible form of $100 million a month having less and less of an “effect” in terms of the central bank’s perspective and desires.
So why do investors keep getting fooled all the time? It’s three main reasons.
One was touched on above.
Two is that the profit motive is a very strong force of its own. Even if an investor is well versed in Austrian theory, and let’s say he refrains from making capital intensive investments after Bernanke lowers interest rates, because he knows the good times won’t last forever, then he will still have to economically compete with other investors who are willing to take the risk of short term profit seeking, and ten getting out before other investors realize the good times are about to end. This is why we always see statistical economic trends over time as rounded at the turnaround points, instead of like steps and flat plateaus. It’s because individuals learn at different rates, and act accordingly at different times. This difference is where actual short term profits can be made: by doing the “wrong” thing according to rational expectations.
Three is that even if 100% of all investors understood the cause of the business cycle, even if they all knew Austrian theory, there is still the unsolvable problem of price distortions. Nobody, not even the most intelligent person in the world, can know for certain what prices and interest rates would have otherwise prevailed without central bank activity. Because of this, everyone, every investor, has to work with a single set of prices and interest rates that are not solely market generated. There is only one set of observable prices. We cannot observe counter-factual “what if” prices. They do not “exist” in the sense of being observable. So even if everyone knows the real market interest rates would have been higher, they cannot know exactly where they would have been higher.
It’s one thing to know that a radio signal would have been more understandable had there been no signal jamming. It’s quite another to know, given there is jamming, what an unjammed signal would actually sound like.
Soltas is effectively claiming that it is “implausible” that radio listeners can’t eventually discern out of the jamming noise what the people on the other end are saying. It’s like he believes if he stares at channel 1 on his television long enough, then through the snow he should eventually start hearing what the aliens are really saying.
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Rational expectations does not take into account the fact that investors disagree with each other as regards to the future. That disagreement is why some investors gain and why some lose. There is no state of the capital market other than what investors think and do. There is no underlying “true” future that all investors can either be right about or be wrong about. The very activity of making predictions of the future affects the very future being predicted in the first place. It’s why humans can plan at all.
Rational expectations assumes one gigantic expectation set of the future of which all investors agree. It can be seen as rather “implausible” just by stating the theory itself.
27. July 2013 at 16:19
Geoff:
Soltas said: “it’s not “Austrian” to fear that.“. You replied: “Uh, yes it is.“.
I think you missed his point. Soltas wasn’t saying “Austrians do not fear this.” He was saying: “you can still reasonably fear this, even if you reject all of Austrian economics.”
What Austrians themselves actually think about the scenario, isn’t really important (for Soltas, or for most educated readers).
27. July 2013 at 18:32
hmmmmm. Evan Soltas has given me something to think about.
27. July 2013 at 19:36
Obama shows his ‘true colors’;
http://thefaintofheart.wordpress.com/2013/07/28/surprisingly-even-obama-suffers-from-inflationphobia/
27. July 2013 at 21:44
OT, but Volcker has a long, intelligently written piece in the latest issue of the New York Review of Books.
Also massively depressing.
Not one paragraph, not one sentence, not one word about NGDP targeting.
But Volcker does provide more paeans and bromides about central bank independence. And the virtues of showing resolve when fighting inflation—but there is more.
The dual mandate? Iffy. Probably better just a single mandate, advocates Volcker. Price stability is key.
And not a single word that the Fed should provide accurate and clear guidance.
Central banker nirvana: No accountability, complete independence. No responsibility for a robust economy, only an exalted mission to keep prices flat. Lots of room for mysticism, opacity, obscurantism.
That is what central bankers want.
The question is, does central banker nirvana work, and is good governance and democracy?
27. July 2013 at 23:12
Don, more like Soltas has learned some bad habits where certain terms are merely code for something.
“you can still reasonably fear this, even if you reject all of Austrian economics.”
No respectable economist rejects all of Austrian economics. The Austrians were the forefront of the marginalist revolution.
The capital theory developed by Menger and Bawerk remains foundational.
Menger -> Eugen von Böhm-Bawerk -> Wicksell -> Irving Fisher
Mises’s early work (ToM&C) is a nice synthesis of economic thought through Wicksell and foreshadows the Monetarist school (inflation is a monetary phenomena) and money supply growth targeting. Hayek (eventually) advocated NGDP targeting.
The equivalence between the ABCT and Austrian is illiterate, ahistorical, and an ad hominem. We don’t need needless synonymies for sophistry, we should try to keep using most words in a technical sense, avoid needless signaling of tribal affiliation.
28. July 2013 at 00:27
What do you think about this?
“Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed world’s currencies will have to bear the brunt of the “adjustment”. Preparations for this by the BRICS nations, led by China, are advancing rapidly.”
http://www.zerohedge.com/news/2013-07-27/gold-and-endgame-inflationary-deflation
28. July 2013 at 04:32
“So here’s the thing about recessions: They reduce businesses revenue.”
This is true but what matters is in fact profits not revenues. Since 2009 US companies reduced AS by cutting costs/headcount which led to rising profits. Contrast this to what happened in Japan in the 1999s 2000s where Japanese firms did not cut costs hence they saw limited growth in profits exacerbating “bad” deflation. However it is not clear to what extent lowering the cost of capital will necessarily increase investment unless firms’ expectation of rising AD shifts. Most firms have taken advantage of the lower cost of capital to drive profits through refinancing instead of maintaining faster productivity growth which is much harder to achieve. (shareholders do not seem to be particularly discerning re: sources of profits) Higher rates of investment are much more likely to be forthcoming once faster productivity growth can be sustained driving up real incomes. It is unclear what monetary policy can do with respect to this problem.
28. July 2013 at 05:15
Your friend Friedman probably would have agreed with NgDp targeting. But unlike Einstein, Friedman couldn’t hold 2 thoughts at the same time to work on if they conflicted.
12/16/59 “I would…make reserve requirements the same for time and demand deposits” & I would eliminate all restrictions on interest payments on deposits” – Leadenham/Archives
We should obviously exit via higher reserve requirements rather than higher interest rates.
28. July 2013 at 05:18
“The central bank’s solution, of course, is to bring down the cost of capital when net present value falls due to fears of weak future demand.” Think about this, folks. It shows how screwy otherwise market-oriented economists’ thinking gets when the subject is the central planning of money. Ask yourself: why wouldn’t the cost of capital _naturally_ decline under the mentioned circumstances if money were competitively supplied?
A more sensible, alternative statement would recognize that recessions happen in part because the central suppliers of currency restrict supply artificially, and so prevent the cost of capital from declining as much as it needs to decline in response to fears of weak future demand. As but one bit of empirical evidence I offer Canada 1930-33: 13% M1 decline w/ decentralized currency as opposed to the U.S.’s 33% decline with centralized currency provision. Of course had the U.S. system not been such a flop, Canada (which depended heavily on exports to the U.S.) would have suffered still less, if it suffered at all.
28. July 2013 at 05:23
Shinzo Abe on Keynesianism: https://twitter.com/ObsoleteDogma/status/361253152357482498
28. July 2013 at 05:24
“happen in part because the central suppliers of currency restrict supply artificially”
There’s no such thing as a business cycle. The Fed invents cycles (creates them ex nihilo). That’s why ngDp targeting will work.
Inflation will take the “front-seat” by year’s end. Roc’s in MVt = roc’s in nominal-gDp (proxy for all transactions in Fisher’s “equation of exchange”.
28. July 2013 at 05:42
Doug and Jason, Good points.
Arierro, He lost me in the first line:
“Excessive monetary stimulus and low interest rates”
Low rates are not easy money.
George, I think it’s implicit in Soltas’s argument that the recession is caused by bad monetary policy. But even if monetary policy is 100% sound, the cost of capital will move around for other reasons.
28. July 2013 at 06:15
I think its best to think about this is terms of capital versus inventors / entrepreneurs.
Assume a system where interest is illegal, and all thats left is equity, and not even publicly traded shares, or transaction costs on shares that make HST and market makers a commodity.
You take your savings you invest it for equity, and you only get paid if the business has profits. You ABSOLUTELY have to bet for profits.
In such a system, the entrepreneurs / inventors take their natural place as the top of the food chain.
This is my optimal invention / churn system. It puts everyone into an anti-govt. mindset, bc the best returns always come from the churn. Getting everyone trying to invent something new, means everyone becomes distrustful of the old.
We want a capitalism that lOVES the young and finds them most beautiful.
So when we think about interest rates being lower allowing MAL-investment, thats wrong.
A lower cost of money borrowing doesn’t let the private sector make bad investments, it forces the capital to take a smaller piece of the returns, and bend to the will of entrepreneurs.
This is recovered by society in the form of faster technological progress.
We get tacocopter, and driverless cars and unlimited lifetime DVRs, and free music and movies, and free collage, and lower cost healthcare, everything simply becomes cheaper faster.
Cheaper faster is the only thing that truly helps the poor.
No one loves the poor more than entrepreneurs.
28. July 2013 at 06:20
The big picture is easier to understand by tracking the use or non-use of savings. If the NBs (of which SBs are a subset), expand faster than the CBs then we get real-growth. If the CB system expands faster than the NBs – then we regress.
28. July 2013 at 08:54
I don’t disagree with your characterization of Solta’s view, Scott. till I think that like many other monetary economists, although he appreciates the harm done by bad monetary policy, he implicitly endorses a bad monetary institution, treating it as a device for “preventing” monetary shortages. The error is the same as in the case in which people portray central banks as devices for “preventing” or “combating” inflation–as if central bankers were doctors and inflation were a disease having some source apart from bad central bank conduct itself.
How people phrase things does matter. In monetary economics the central bankers as benevolent doctors or heroes or whatever has served to make people blind to the inherent shortcomings of centralized monetary control by treating monetary shortages are “market” failures rather than failures of government-erected monetary institutions.
And allow me this time to make clear, Scott, that my remarks are aimed at Solta’s statement, not at your own views.
28. July 2013 at 09:54
Thanks, Scott, for quoting the piece. Had I known you’d open it up for discussion, I might have spent a little more time refining my thoughts there!
I’ll try to react to the commenters on my stuff.
@DougM: Thanks, and if you listen to the standard Keynesian narrative for the last recession, it implies a consumption-led downturn. This, obviously, does a very poor job matching the data. What I have trouble with, then, is understanding why employment is so sensitive to investment — and, more generally, why are long-run expectations so volatile? It seems like the long-run trend, signaled by consumption, is pretty clear, with lots of bouncing from investment. I guess you can believe a few things: (1) borrowing constraints force layoffs or (2) expectations really are that volatile. I think I put more weight in (1) than (2), and it would be interesting to see research as to how much of the cyclical swing in employment is driven by borrowing-constrained firms.
@jknarr: I think I am more willing that Scott is to read interest rates in context — my sense is that he’s inclined to never reason from them ever. I think a stronger response to the “low interest rates are driving malinvestment” claim might be “you have to look at the interest rate relative to how depressed internal rates of return are now due to weak future demand.”
@Geoff: Thanks for your long and detailed comment. I have a few responses. First, you make a good point that investors may do things that appear on their face irrational because their hand is forced by expectations of other people not making optimal decisions. This point comes from the literature on “noise traders” as well as the “what’s 2/3rds of the average” game. So I’ll grant the point that this pile-on behavior explains much of the business cycle. What I won’t grant, and what you failed to convince me of, was a view of the business cycle I think sounds religious. It’s that only Austrians understand the boom-and-bust, so non-Austrian business owners who fall into the pattern just don’t see that they are repeating history. My critique is effectively an intellectual version of the efficient markets hypothesis: If the Austrians have always been right, why aren’t we all Austrians already? How can you be so certain about the nature of the boom and bust when your critique of my view is that the signal is hard to read? There are some knotty contradictions in your position here that you have overlooked. My view, to restate it, is that people aren’t delusional. When malinvestment occurs, it is an individually rational response to incentives, with agents thinking through the long and short runs.
@DonGeddis: Yes, this is what I am saying: Even if you don’t subscribe to Austrian economics — and, to respond at the same time to @Jon, I don’t consider myself an Austrian but appreciate that they have made a number of key contributions to the field — you can believe this. My point about malinvestment fits right into orthodox economics, and all I’m using is NPV and IRR.
@Tom: Yes, and you’ll notice that the model was one of net cash flows over time.
@GeorgeSelgin: Isn’t your point about competitive currencies somewhat of a red herring here? Yes, interest rates would fall in such a scenario — but we’re so insanely far from competitive currencies that I’m not clear why you’re objecting to a Pareto improvement (adjusting the interest rate with changes in internal rates of return).
28. July 2013 at 11:17
Evan Soltas wrote:
“My view, to restate it, is that people aren’t delusional. When malinvestment occurs, it is an individually rational response to incentives, with agents thinking through the long and short runs.”
I’m not sure that the Austrians would disagree with you on this point (though I’m far from an expert in ABCT).
Imagine a ranked list of all of your potential investment opportunities, from highest internal rates of return to lowest. There would obviously be a point on your list where investments were no longer profitable.
I think the Austrian argument would be that if the Fed were to depress interest rates inappropriately, it would not just change where the profitable/non-profitable line is drawn in your list. Rather, it would, to some extent, cause you to rearrange your list in a way that made perfect sense given the information available to you, but would not be sustainable in the long run.
That being said, the whole thing seems like too much of a “just so story” to me. I can’t for the life of me understand why artificially high interest rates (e.g. tight money) would not do exactly the same thing. Or why the price system would not eventually restore equillibrium (Imagine that scarce resources are deployed producing a product (say, houses in Arizona) that will ultimately not be sold at a profit. This means that those resources could otherwise have been used to produce something else (call it X) that could have been sold profitably. Since we did not, in fact, produce X, we must now have a relative shortage of X, leading the price of X to go up which should be a signal to producers to ramp up production of X).
Bill Woolsey has some outstanding recent blog posts where he delves into this issue in some detail.
28. July 2013 at 11:50
Evan:
“What I won’t grant, and what you failed to convince me of, was a view of the business cycle I think sounds religious. It’s that only Austrians understand the boom-and-bust, so non-Austrian business owners who fall into the pattern just don’t see that they are repeating history.”
Every school of economics has their own unique ideas of what causes this and that in the economy. I wouldn’t call your posts “religious” if they purported to say something true about the world, which of course implies that all contradictory views are false, which implies your view “the correct one” relative to all those that contradict it.
Is it religious for Dr. Sumner to argue that non-Market Monetarists, or those who reject NGDPLT, are wrong, while he is right?
I think that perhaps you are finding out that when you can’t penetrate a particular school of thought without a radical overhaul of your own metaphysical and epistemological convictions, that school appears “out of this world”, like a religious cult. But I can assure you, Austrian theory only asserts with absolute certainty that individuals act. There is nothing religious about this. It is Earthly inquiry par excellence. There is not even a bird’s eye view implicit in it, the way it is implicit in Keynesianism and Monetarism. If anything, Austrianism is intellectually less religious than the other schools.
“My critique is effectively an intellectual version of the efficient markets hypothesis: If the Austrians have always been right, why aren’t we all Austrians already?”
If your view is more right than wrong, why do so many people in the world hold an opposing view?
If the truth is out there, known by someone, why doesn’t everyone agree with that person, thus making that truth generally known?
Prima facie, your question seems like a trenchant one, but it actually contains an implicit non sequitur. That is the assumption that truth, once discovered, ipso facto advances throughout the minds of the general population, as if truth has a force of its own, apart from, and above, individual motives and circumstances.
So what are these individual motives that prevent or hamper truths from spreading throughout the minds of the general population? Well, there are many, but in general, anti-establishment theory such as Austrian theory contain ideas that go directly against entrenched power structures. These have in part arisen due to a lack of anti-establishment theory being taught to children and university/college students, and, equally, a positive presence of such power structures financing and encouraging those ideas that perpetuate itself.
Power is, for many, equally important, and oftentimes even more important, than scientific truth. Witness the Soviet and German regimes in the early to late 20th century. Lies and propaganda dominated the intellectual establishments. Why? Because power became held as a “truth” in its own right.
In the US, do you think the Rockefeller Foundation financed the University of Chicago throughout the 1910s, 20s and 30s because it wanted to learn how to eliminate financial oligarchies from society? Or to have bright minds make careers out of researching “optimal” inflation rules of said oligarchy, in order to perpetuate it?
Going back further, it took many centuries for the modern scientific method to finally dislodge the church’s monopoly on naturalist inquiry. Imagine what you are saying to me here to have been said during the 16th century to Copernicus: “If your idea about the heavens is so good, why do we have thousands of years of history that say otherwise, and why are there so many people who are still antagonistic towards your theory?”
Radical ideas, such as Austrian theory, have to go through many years of antagonism, before the truth of it can no longer be ignored or rejected, until at last it becomes generally accepted. It has to overturn the intellectual establishment of multi-trillion dollar enterprises. This is not something like a new physics theory where politics plays little role. This is a theory that would overturn a century of financial dominance, it would put incredible pressure on the existing economics establishment financed in large part by that same financial power centres.
There is no universal law that makes true statements instantly accepted by the general population.
Almost everyone is taught in school for example that central banks are, generally speaking, socially beneficial. Austrian theory holds it as responsible for millions of people foisted into unemployment. When you have that power structure financing virtually all of the economics education and research, from grade school to doctoral programs, it should not be surprising that Austrian theory is relegated to “heterodox” teachings on the internet, while Keynesianism and Monetarism dominate the intellectual establishment.
“How can you be so certain about the nature of the boom and bust when your critique of my view is that the signal is hard to read? There are some knotty contradictions in your position here that you have overlooked.”
I don’t see how that is a contradiction, because the signal I am referring to is not the signal that tells me the credit-inflation-malinvestment theory is sound while yours is not.
The jammed signals refer to the price system signals that can’t get through to investors and consumers clearly because the central bank is jamming those signals. I don’t have to actually observe unhampered prices in order to know that the prices that exist today are not unhampered prices.
So how am I so sure? How are you so sure there is a contradiction in what I said? We are sure in accordance with a rational foundation. It’s what we have to work with. We sometimes err, but to ask anyone why they are so sure, is to basically attack their ability to reason.
“My view, to restate it, is that people aren’t delusional. When malinvestment occurs, it is an individually rational response to incentives, with agents thinking through the long and short runs.”
I agree with that. However I think there is more to your theory than what is encompassed in that passage.
28. July 2013 at 12:01
Don Geddis:
“Soltas wasn’t saying “Austrians do not fear this.” He was saying: “you can still reasonably fear this, even if you reject all of Austrian economics.””
I know that he wasn’t saying “Austrians don’t fear this.” I was saying that if you are concerned with what Soltas was alluding to, that it makes that fear an Austrian one. You can’t fear that and not be an Austrian in this particular issue.
Nobody is 100% Austrian, because it’s just a body of ideas. I don’t think any Austrian agrees with the exact same body of ideas. Rothbard and Mises disagreed on some points for example. Some Austrians today disagree with both Rothbard and Mises.
I think what’s going on here is that people want to accept an Austrian idea, without being called an Austrian, for the sake of appearences. Soltas doesn’t want to be labelled an Austrian just because he might find one particular Austrian idea plausible. That’s a valid point, one I will agree with, but I will consider the fear he referred to as an Austrian one.
“What Austrians themselves actually think about the scenario, isn’t really important (for Soltas, or for most educated readers).”
The theory referred to originated from the Austrians. What, are you going to steal it and claim originality? Soltas is mentioning it because of what Austrian economists have written in the past, and what he has heard by others since. I would think that the opinions of the experts on the subject matter are more important than you are suggesting.
28. July 2013 at 12:20
George Selgin:
“A more sensible, alternative statement would recognize that recessions happen in part because the central suppliers of currency restrict supply artificially, and so prevent the cost of capital from declining as much as it needs to decline in response to fears of weak future demand.”
Can you explain what is meant by “artificially” here?
If a central bank has full control over the money supply, and issues a currency that would almost certainly not be accepted as money in a free market, isn’t that money always “artificial”?
The only plausible meaning I can see for that term, given that we include the implied idea that “non-artificial” money can potentially take place in a central banking system, would be that there really does exist a “non-artificial” centralized monetary inflation rule.
I don’t see how a person can separate all inflation rules into “artificial” and “non-artificial” buckets without deferring back to their own personal subjective values, which of course have to overrule everyone else’s values in order for that rule to be enforced.
“As but one bit of empirical evidence I offer Canada 1930-33: 13% M1 decline w/ decentralized currency as opposed to the U.S.’s 33% decline with centralized currency provision. Of course had the U.S. system not been such a flop, Canada (which depended heavily on exports to the U.S.) would have suffered still less, if it suffered at all.”
This is interesting. Does this justify inquiring into the economics of the deflationary pressures in a decentralized monetary order versus a centralized monetary order? At first blush it makes sense that deflationary pressures would be lower (and inflationary pressure as well?) the more decentralized the system. I mean, I don’t recall any shortages of computers or potatoes or other goods produced in the current relatively decentralized production of those goods.
28. July 2013 at 14:06
Geoff and Evan,
My only point is that it is misleading to employ the language of market failure (e.g. by speaking of a central bank “solution” to the problem of “artificially” high cost of federal funds)in a context in which the “market” alternative itself remains unexamined; and this is true no matter how “far off” that alternative might be from actual circumstances. By “artificially high” I simply mean high relative to what is needed to eliminate an excess demand for real balances at prevailing P and (E)P’.
Almost everyone talks in the manner to which I object, and I’m not so naive as to expect many to climb aboard the competing currencies bandwagon, sputtering little jalopy that it is. But I do wish more economists would resist the habit of speaking of central banks as if they existed to “correct” some tendency, not stemming from their own presence, for money to occasionally become too tight (or too easy). What they should say, instead, IMHO, is that the task before the world’s central banks is (to put it bluntly) to take whatever steps they can to fuck their economies up as little as possible. Bagehot understood this in framing his argument to the effect that during crises CB’s should act as lenders of last resort. I look forward to a time when all monetary economiksts understand it.
28. July 2013 at 14:07
Geoff and Evan,
My only point is that it is misleading to employ the language of market failure (e.g. by speaking of a central bank “solution” to the problem of “artificially” high cost of federal funds)in a context in which the “market” alternative itself remains unexamined; and this is true no matter how “far off” that alternative might be from actual circumstances. By “artificially high” I simply mean high relative to what is needed to eliminate an excess demand for real balances at prevailing P and (E)P’.
Almost everyone talks in the manner to which I object, and I’m not so naive as to expect many to climb aboard the competing currencies bandwagon, sputtering little jalopy that it is. But I do wish more economists would resist the habit of speaking of central banks as if they existed to “correct” some tendency, not stemming from their own presence, for money to occasionally become too tight (or too easy). What they should say, instead, IMHO, is that the task before the world’s central banks is (to put it bluntly) to take whatever steps they can to fuck their economies up as little as possible. Bagehot understood this in framing his argument to the effect that during crises CB’s should act as lenders of last resort. I look forward to a time when all monetary economists understand it.
28. July 2013 at 20:39
I don’t even quite buy the notion that the Fed causes falling real interest rates to increase potential malinvestment. In normal conditions, they might have an effect on short term rates, but if assets and liabilities are being matched in the marketplace, then any investments that are made because of Fed induced interest rate changes should be investments whose IRR is specific to the short term period of time when those rates are in place. Longer term rates are going to reflect long term market expectations, so we shouldn’t expect any short term rate fluctuations emanating from the Fed to effect long term investments in a way that will cause their IRR to be dependent short term manipulated rates.
28. July 2013 at 20:57
George, I have some sympathy for both your position and Evan’s. For my part I’ve devoted endless posts to complaining that people should not talk about whether the Bernanke Fed did or did not do enough to rescue the economy after the financial crisis of 2008, and should start talking about the Fed as the cause of the severe recession of 2008-09.
29. July 2013 at 03:45
Scott, to your question. I believe your and Evans’ theories do fit together here. Great stuff from both of you, very thoughtful.
29. July 2013 at 16:08
[…] Soltas (HT2 Scott Sumner) writes a more balanced view (compared to Matt Yglesias, who called Summers a communist) on Larry […]
29. July 2013 at 16:24
Dough, about your claim that investment spending fluctuates much wider than consumption:
I notice though that Supply Side theory doesn’t market itself as a counter-cyclical theory. Ie, they push for deep tax cuts for the rich during booms. They mostly don’t believe it’s possible to do anything about the business cycle-other than wait for the labor market to self-correct.
Or take Sumner: he’s both a-Market-Monetarist-and a Supply Sider-he doesn’t call for SS taxes to end a recession.
It seems that SS theory is more about achieving a better long term business cycle, not dealing with short term slowdowns and crises.
31. July 2013 at 18:03
George Selgin:
“My only point is that it is misleading to employ the language of market failure (e.g. by speaking of a central bank “solution” to the problem of “artificially” high cost of federal funds)in a context in which the “market” alternative itself remains unexamined; and this is true no matter how “far off” that alternative might be from actual circumstances. By “artificially high” I simply mean high relative to what is needed to eliminate an excess demand for real balances at prevailing P and (E)P’.” (bold added).
Is this is not just moving the same problem one step back?
The term “excess” also connotes a subjective value judgment, since it is a praxeologically constrained concept. Thus your value judgment for what constitutes “excess” must become “the” excess, which means everyone else’s value judgments for what is excessive and inexessive, must be overruled by the force of centralized power which is guided by your value judgment.
“Almost everyone talks in the manner to which I object, and I’m not so naive as to expect many to climb aboard the competing currencies bandwagon, sputtering little jalopy that it is. But I do wish more economists would resist the habit of speaking of central banks as if they existed to “correct” some tendency, not stemming from their own presence, for money to occasionally become too tight (or too easy). What they should say, instead, IMHO, is that the task before the world’s central banks is (to put it bluntly) to take whatever steps they can to fuck their economies up as little as possible. Bagehot understood this in framing his argument to the effect that during crises CB’s should act as lenders of last resort. I look forward to a time when all monetary economiksts understand it.”
I think you and I are on the same page, but, IMHO, I think it’s impossible not to think about economic issues in terms of subjective values, because I think just like you object to the manner in which almost everyone speaks, I would like to make an objection to your usage of “artificially” and “excess”. Not in the sense that I think “how dare he”, but more of an objection to what you are actually saying, versus what you think you are saying.
To reiterate, I think anyone who talks about centralized (coercive) solutions to social problems, they cannot help but introduce their own subjective value judgments into the mix, and, inadvertantly or otherwise, elevate those judgments to the “macro” policy sphere such that everyone else’s judgments must be squashed.
I think people getting on board with competing currencies is such a chore because we have not sufficiently spread the idea that one is always referring to one’s own personal value judgments when the topic is monetary policy. The penchant of it being given a technocratic, seemingly value free mathematical appearance cannot eliminate this. So many times I see Dr. Sumner and others speak about their personal values in the sphere of monetary policy as if they are objective, scientific laws that are not to be questioned, but obeyed.
Without centralized monopoly power, to what field of inquiry will monetarists devote their intellectual efforts? I don’t think devoting one’s life to figuring out how the Fed can minimally fuck up the economy is going to result in anything but the Fed continually fucking up the economy, because central planning doesn’t work. Even if one believes one has improved things, one really hasn’t, but only made the short term appear better, delaying the day of reckoning to the future.
I mean, going from lender of last resort, to daily ongoing inflation targeting prices…did that make us better off in terms of sustainable growth?
Those who believe NGDPLT is a step up I think underestimate the learning, adaptive nature of humanity. They are holding things constant that are not constant. If NGDPLT is imposed, then any short term gratification will only make the longer term consequences even MORE severe.
I think that the recession of 2008-2009 was a GOOD thing, in the sense of purging the economy of at least some malinvestment that could only take place with a sufficient drop in NGDP. Unfortunately, so many people are so myopic in their thinking that any pain, no matter the origin or long term benefit, should be stopped by the Fed doctor, as if any and all pain is evil. But I think only a receding tide can reveal who isn’t wearing a swimming suit.
I feel pain after a lengthy jog. According to Monetarist (and Keynesian) ideology, I should never have left my home, and should have targeted short term pleasure instead.
There is a such a thing as “good” pain, and it’s high time the 2009 recession haters realized that.
31. July 2013 at 18:09
Every time someone sets about intellectually tinkering and “improving” the rate of inflation of the Fed, they are, at the same time, intellectually sanctioning purchasing power redistributive looting on a massive scale.
I know this is true because every time I bring the latter up, I am always given a “It’s not as bad as…” type of a response, which of course is a concession of the point.