Tuesday, November 11, 2008
Consumers Don't Cause Recessions
Ah, I have outdone myself in this one. You know how you've wanted someone to rip apart the "circular flow diagram" for years? Well, enjoy. Learn it. Live it. Love it. Here's an excerpt for those readers who are "busy" and need a hint before clicking a link:
In his discussion of the "paradox of thrift," Paul Krugman proves that he is not an economist—or at least, not a very good one. His policy recommendations are based on a Keynesian model bereft of time and the capital structure of production. Recessions are rooted in misalignments in this unbelievably complex structure, and there needs to be a period of below-normal output as these pipelines are fixed. Most important, consumers are doing the right thing when they increase their saving during a downturn. If solving a recession really were as simple as getting people to spend, then we wouldn't keep experiencing them.
Comments:
I, Pencil came to mind reading the parts about the "pipeline" of production.
# posted by 
: November 11, 2008 at 1:03 PM
: November 11, 2008 at 1:03 PM
Hey Robert,
I am not an economist, as you will soon figure out. I have read your article, and one thing that has confused me for while came up.
Quote: The reason humans in the 21st century are so fantastically wealthy compared to those in the 11th century is not merely a matter of technological innovation. It is also the result of the growing inventories of machines, tools, and equipment (i.e., "capital goods") that have been bequeathed from generation to generation.
I understand that these "growing inventories" of capital goods is in effect an accumulation of capital, through the savings and investments ("thrift") of many people. OK, that makes sense.
Help me understand the difference between whether the economy gains that capital -
1) through individual thrift, or
2) through corporate income, resulting from consumer spending ("consumption").
Does the question makes sense?
Greg
I am not an economist, as you will soon figure out. I have read your article, and one thing that has confused me for while came up.
Quote: The reason humans in the 21st century are so fantastically wealthy compared to those in the 11th century is not merely a matter of technological innovation. It is also the result of the growing inventories of machines, tools, and equipment (i.e., "capital goods") that have been bequeathed from generation to generation.
I understand that these "growing inventories" of capital goods is in effect an accumulation of capital, through the savings and investments ("thrift") of many people. OK, that makes sense.
Help me understand the difference between whether the economy gains that capital -
1) through individual thrift, or
2) through corporate income, resulting from consumer spending ("consumption").
Does the question makes sense?
Greg
Bob,
Are there any Austrians commenting on what is going to happen at the upcoming G-20 meeting in Washington DC? I hear it being called Bretton Woods II. Is something major going to happen?
Dave
Are there any Austrians commenting on what is going to happen at the upcoming G-20 meeting in Washington DC? I hear it being called Bretton Woods II. Is something major going to happen?
Dave
Thanks for writing that...I've been hearing a lot about the paradox of thrift and couldn't quite figure out why it was wrong in a technical sense, although I knew it was in a real-world sense.
For those of us who are visually oriented, an Austrian version of the circular diagram would be extra helpful!
For those of us who are visually oriented, an Austrian version of the circular diagram would be extra helpful!
# posted by : November 11, 2008 at 5:02 PM
: November 11, 2008 at 5:02 PM
Anon #2, the Austrian circular flow diagram would probably be the Hayekian triangle. For that, I refer you to Garrison's cool PowerPoint shows. (The shows are Garrison's, but the Hayekian triangle is, well, Hayek's.)
Greg,
The question makes sense, but even individual thrift is only possible if there is first income to save. So if you think that corporations need spending in order to invest, then you should also think individuals need paychecks (coming ultimately from spending) in order to save.
But on that level, it's a chicken and egg thing. People can't spend unless they have income.
There is no starting point in the circular flow model.
In contrast, if you think about it in terms of the Mengerian structure of production, then you can trace the physical transformation of natural resources into finished consumer goods. And it's obvious that you need to actually produce stuff before you can consume it.
The question makes sense, but even individual thrift is only possible if there is first income to save. So if you think that corporations need spending in order to invest, then you should also think individuals need paychecks (coming ultimately from spending) in order to save.
But on that level, it's a chicken and egg thing. People can't spend unless they have income.
There is no starting point in the circular flow model.
In contrast, if you think about it in terms of the Mengerian structure of production, then you can trace the physical transformation of natural resources into finished consumer goods. And it's obvious that you need to actually produce stuff before you can consume it.
David,
Some people have been chattering about it at the LRC blog, but I haven't seen any full-length articles on it.
Some people have been chattering about it at the LRC blog, but I haven't seen any full-length articles on it.
Anon #1, yep, I probably should have linked to "I, Pencil" in that part since I was drawing on it so much.
Dr. Murphy,
Thanks for the article, I found it very informative.
However, a part of me still thinks that Keynesians have a point, even if their macro tools are limited when compared to Austrian capital theory. Specifically, if consumption dropped not because people were saving, but because they were getting laid off (and thus had less to spend), entrepreneurs would not have more future consumption to look forward to. If the employees were being laid off due to a "credit crunch" or an unanticipated reduction in the money supply, the employers wouldn't have any extra cash either. What would be the mechanism to stop the deflationary spiral in that scenario?
Finally, surely the New or Post Keynesians have answered the Austrian truism that savings is future consumption, and not the lack of consumption?
Thanks for the article, I found it very informative.
However, a part of me still thinks that Keynesians have a point, even if their macro tools are limited when compared to Austrian capital theory. Specifically, if consumption dropped not because people were saving, but because they were getting laid off (and thus had less to spend), entrepreneurs would not have more future consumption to look forward to. If the employees were being laid off due to a "credit crunch" or an unanticipated reduction in the money supply, the employers wouldn't have any extra cash either. What would be the mechanism to stop the deflationary spiral in that scenario?
Finally, surely the New or Post Keynesians have answered the Austrian truism that savings is future consumption, and not the lack of consumption?
Grant,
I tried to answer your scenarios in the article. I acknowledged that the drop in consumer spending right now isn't analogous to people deciding to save up for a summer cruise. And I tried to show how the government "solutions" would mess things up even here.
E.g. if there is nothing physically wrong with the capital structure, and people are just spooked for some reason, then you don't reassure them and get producers confident in a stream of future revenues by going, "Omigosh omigosh! We need to nationalize the banks! We need $700 billion and no oversight! Now now now!"
Of course, Krugman would agree that the scare tactics were counterproductive, but I think even "calm" pronouncements that the government must jump-start the economy out of a deflationary spiral would be fear-inducing. If there's really nothing wrong except irrational fear, then I think that would go away by itself soon enough.
Post a Comment
I tried to answer your scenarios in the article. I acknowledged that the drop in consumer spending right now isn't analogous to people deciding to save up for a summer cruise. And I tried to show how the government "solutions" would mess things up even here.
E.g. if there is nothing physically wrong with the capital structure, and people are just spooked for some reason, then you don't reassure them and get producers confident in a stream of future revenues by going, "Omigosh omigosh! We need to nationalize the banks! We need $700 billion and no oversight! Now now now!"
Of course, Krugman would agree that the scare tactics were counterproductive, but I think even "calm" pronouncements that the government must jump-start the economy out of a deflationary spiral would be fear-inducing. If there's really nothing wrong except irrational fear, then I think that would go away by itself soon enough.
Subscribe to Post Comments [Atom]
<< Home
Subscribe to Posts [Atom]