Sunday, June 21, 2009

 

Austrians: Our Victory Is Complete

Discussing Krugman's racy PIMCO quote, Scott Sumner says:
As everyone knows by now the once kooky and discredited Austrian business cycle model has now become conventional wisdom. Easy money creates bubbles, which inevitably cause depressions when they pop. It’s Greenspan’s fault. Paul and I are still not on board the Vienna express, but we are in an awkward position. (Thank God I didn’t have a blog in 2002!)

So the above is refreshingly funny and humble, but then Sumner goes on to say:
Here’s what I think is a defensible view of what Paul might have meant...The words are mine [Scott Sumner's--RPM], not Paul’s:

“Business investment is tanking. A sharp fall in overall investment can often lead to a depression. The Fed should reduce interest rates...Because tech is so overbuilt, the lower interest rates may not be enough to bring business investment back to normal levels, instead other types of investment and consumer durables will have to pick up the slack. We can expect the housing sector to expand if rates are cut sharply....In the classical model we would then be moving along the investment PPF from less business investment to more housing investment, instead of moving far inside the PPF (as in the 1930s) with less overall investment as the economy tanks. Let’s hope bankers lend money to people who are likely to repay their loans, so that the bankers do not lose hundreds of billions of dollars, and their jobs. Monetary policy has no choice but to proceed on the assumption that we should stabilize the overall macroeconomy, and let the private sector decide where to allocate resources.

Oh Scott Scott Scott. The issue about the PPF is tricky; as Garrison's PowerPoint [.ppt] make clear, the problem of an unsustainable boom is that the low interest rates lead to greater (apparent) investment and consumption. That is physically impossible, which Garrison denotes by showing the economy moving beyond the (sustainable) PPF.

But the real problem is that part I put in bold. This is the primary weakness in all Keynesian (and Chicagoan) demand-management prescriptions. What exactly does the interest rate do in a market economy, according to these economists? Scott's statement is like saying, "I'm not saying the government should stimulate the health care sector, I'm just saying it should subsidize stethoscopes."

In case I'm being too cute: What I'm saying is that the interest rate is a price that allocates investment among projects of different length. It's not merely a lever for "more investment or less?" To lower interest rates, in the hope of spurring total spending while ignoring the distortions among choice of investment projects, would be akin to raising taxes on labor and not realizing this would affect hair salons more than oil rigs.



Comments:
hooray, you won marginal respect from the mainstream and are no longer considered entirely kooky. heck, all it took was 80 years, a nobel memorial prize, and the prediction of the two greatest economic collapses in modern history! :D
 
Oh Bob, you could never be too cute to me ;-)
 
Oh, it's easy to understand their position.

(1) The interest rate is a price - the price of money - that has impacts on aggregate demand.

(2) Since money, in itself, doesn't matter, it's not a big deal to distort its price - especially if we can avoid depressions through that distortion.

I think the needed step is to hammer home that interest rates are most definitely NOT the "price of money". Instead, it's something closer to the price of time (personally, I think it's more accurate to say that it's the "price of present money in terms of future money", but the "present" and "future" parts are more important than the "money" part). Since different production processes require different periods of time, it makes sense that changing the price of time would distort the choice of production processes.

Once we get that message out, we may make some more headway.
 
Bob, My own view is that the Fed should not target interest rates, rather they should target NGDP. In contrast, Austrians like Garrison say they should target NGDP. Oh wait, there is no contrast. I picked interest rates because both Krugman and the Fed see interest rates as a tool to control the macroeconomy. So I was trying to explain why if they insist on using interest rates as a tool, then lower rates might have been necessary to get the appropriate level of NGDP. I do disagree with Austrians about the appropriate rate of NGDP growth, but that was not addressed in your post, so I think you left your Austrian readers with the impression that I am more Keynesian than I really am. But I can see why, because that is a natural reading of the way I wrote the post, which was trying to show what Krugman (a Keynesian) might have been thinking. I'm a bit more Austrian than Krugman. (But still not "kooky," rather I am a monetary crank.)
 
Scott Sumner,

I would imagine you aren't an advocate of private theft. Why then, do you advocate for public theft?

Even more puzzling, why do you believe that public theft will make everybody else better off?

Do you understand what you say? It doesn't seem you do, unfortunately.
 
David Friedman has a post about the power of the mix of free information that is a counter to his son Patri... I'm thinking Patri wins on this one:

"enormously popular by libertarian standard... during a time of enormous backlash against the establishment, never had the slightest chance..." (about Ron Paul, but applying to ABCT)

An incomplete victory...
 
I think Yeager put this well -- the interest rate is the price of waiting.
 
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