Sunday, August 1, 2010

Jonathan's Liquidity Trap Article

I've gotten a chance to read Jonathan's Mises Daily article on the liquidity trap, and I certainly don't regret recommending it in previous posts - it's very good. I jotted down thoughts as I was reading it, so I think the best way to present it in a blog post is just to go through the points the caught my eye, quoting him and then posting my response to him. It might be hard to follow this without reading the article, but I'm not sure how else to organize my essentailly bullet-point response.

JFC: “Broadly speaking, the economics profession is divided into two camps. One side is made up of "liquidationists" and "deficit hawks," supporting tight monetary policy and low — or no — government spending. The other group is composed of those fearing a fall in prices, who support easy credit and expansive fiscal policy to combat it.”

- I don’t think deflation is the primary concern – although it is an important one. Depressed output is the primary concern, and deflation is a concern because of the complicating factors it introduces to a depressed environment. The fact that this is not the major bone of contention is made clear by Hayek and Rothbard’s insistence that deflation is problematic, as well as recent expressions of the Austrian School’s allegedly close relationship to monetary disequilibrium theory.

- We need to appreciate how Jonathan goes on to delve deeply into the literature that provides context to this debate. For example, Krugman’s treatment of the Austrian school in 1998 isn’t strictly necessary for understanding his view of the liquidity trap. I’m not personally familiar with the details of this exchange, but Jonathan has done impressive due diligence by providing all these references here.

- On Krugman’s recent treatment of Hayek – I think the critique of Krugman has been overdone. I agree with Jonathan that Krugman doesn’t really seem to demonstrate an understanding of the macroeconomics of the capital structure (although he’s closer than many suspect – he does the sort of sub-sector analysis in his critiques that I’ve never seen an Austrian do thoroughly. I complain often on here about the lack of empirical verification of Austrian theory – Krugman’s blog comes closer to doing that than mises.org does). But he does correctly summarize what Hayek has said: that a “slow process of adapting the structure of production” is necessary. That sure sounds like we have to just wait and suffer through unemployment to me. Didn’t Mises call this purging the rot out of the system? I think we’re being disingenuous if we don’t accept that the Austrian school sees high unemployment as, to a certain extent, functional.

But later, Jonathan seems to agree with Krugman! He writes:

JFC: “This [the "Misesian-Hayekian" malinvestment framework] suggests — like Krugman accuses — that following a boom of malinvestment there will be a period of relatively high unemployment.”

If he really thought that, he shouldn’t have said that Krugman was “erroneous”.

Jonathan zeroes in on what I agree is the important point:

JFC: “As a general concept, the liquidity trap is legitimate in the sense that we are currently in a situation in which, despite the extreme provision of liquidity on the part of the Federal Reserve, there has not been a substantial increase in real private investment. As such, any Austrian rebuttal to Krugman should concede this point.

The real debate is whether or not fiscal stimulus can effectively revive an economy (or pull it out of a "liquidity trap") or if fiscal stimulus contributes to the existence of a liquidity trap — there is the distinct possibility that this so-called liquidity trap is the product of regime uncertainty, which may or may not be aggravated by government policy.”

- And it’s about more than just that. Does monetary policy work? The original purpose of highlighting the liquidity trap was to demonstrate a circumstance under which it wouldn’t. But is that really the case? A lot of people don’t think that is the case. I’m not sure what I think, but I’ve been content to say that “monetary policy is less effective in a liquidity trap than it would otherwise be”

- When he describes the liquidity trap here, he’s really describing the symptoms rather than the underlying cause. That’s fair enough, but it would have been nice to explain exactly what a liquidity trap is near the beginning: it is a situation where cash and bonds become interchangeable. How that is depicted in a model has been debated, but that’s the fundamental point.

JFC: “Keynes believed that such a situation occurs out of a change in the "state of expectation."[10] In other words, an increase in uncertainty leads to an increase in the demand to hold money and a decrease in investment,[11] based on the belief that money's relatively riskless qualities makes it more desirable to hold than bonds and assets”

- Yes, there’s that – but presumably the risk premium can be compensated for. The point is, at low interest rates there is no longer any compensation for the risk. So I think the key here is the interest rate, not the relative risk.

JFC: “Given a "virtually absolute" liquidity preference, monetary policy becomes ineffective at stimulating "aggregate demand" since an increase in the supply of money cannot increase wage-earners' incomes.”

- Does monetary policy stimulate aggregate demand by increasing wage-earners’ incomes or by lowering the interest rate? I always thought it was lowering the interest rate.

JFC: "Between 1940 and 1970, the liquidity-trap theory went through major changes and reformulations, only for Hicks to recant, suggesting that, "[w]hile one can understand that large balances may be held idle for considerable periods, for a speculative motive, it is harder to grant that they can be so held indefinitely."[24]"

- I’ve always been suspicious of this “recantation” by Hicks. Whoever said they would be held indefinitely? I know Hicks’s change of heart was broader than this and perhaps there was more to it than this, but this particular quote never struck me as particularly convincing. He seems to be recanting a strawman, in other words. I don't see the later Hicks making a convincing argumetn against the earlier Hicks, in other words.

JFC: “Where Krugman parts ways with Keynesian precedents is in applying a theory of intertemporal expectations, where monetary policy is ineffective because of the expectation of future deflation — the public believes monetary policy to be only temporary, as opposed to sustained.”

- This is actually probably better put as “Krugman parts ways with Hicksian precedent”. Keynes actually uses these expectations arguments quite frequently in the General Theory. Hicks put it into a static model, so a lot of the original Keynesian discussions of expectations were forgotten. I don’t mean to be argumentative with Jonathan on this point – I actually mean to deflate Krugman’s originality a little bit and give more credit to Keynes (who may not deserve original credit himself, in all likelihood).

JFC: “While Keynes and Hicks would have perhaps shied away from massive monetary stimulus, operating with the understanding that monetary policy was ineffective during a liquidity trap, New Keynesian theory puts much more importance on a growing money supply.”

- This is what I’ve always thought as well, and that’s the impression I get from the General Theory, but what’s interesting is that Keynes does express a very similar monetary prescription in an open letter he wrote to Roosevelt – I believe in 1938. He said two things were needed: fiscal stimulus, and the reduction of long-term interest rates. Presumably one would reduce long-term interest rates with the sort of quantitative easing policies being proposed today.

JFC: “Austrians instead see the resulting fall in the price level as the cure for deflation (or fall in the money supply).[54] Recognizing the problem as the result of a fall in profit, due to the deceleration of credit expansion, the problem of demand necessarily stems from the inability to pay for products demanded. The solution is a fall in prices of relevant goods and services, to the point where demand for them can once again rise.[55] In other words, conceding that a fall in the money supply will lead to a decline in spending, the only method by which spending can rise is through a fall in the price level.”

- I could see why a falling price level as a "solution" would result in re-equilibration. I don’t see how it addresses the fundamental dynamics of the deflationary spiral. The whole point of the deflationary spiral is that deflation further constricts the money supply, which causes more deflation. At some point, one may think that a real balances effect would put a brake on this. I am more persuaded by the idea that at some point the need to replace capital will put a brake on this. Either way – simply letting prices fall alone doesn’t seem to provide a solution to a problem that is caused by falling prices, unless you reject the logic of a deflationary spiral in the first place (which Jonathan doesn’t seem to).

JFC: “The alternative method, or the Keynesian "solution" of inflation, can lead to a temporary "recovery."[56] Nonetheless, such a policy would inevitably result in greater malinvestment and a greater net loss of wealth.[57]”

- This is probably an instance where it would have been better to distinguish between Keynes and Krugman explicitly. Not that inflation didn’t play an important role for Keynes, but it plays a much more important role for Krugman. However, I think even for Krugman this is only the monetary half of the story.

JFC: “However, rising uncertainty and low expectations for the future, brought about by economic depression, can be considered legitimate factors behind a liquidity trap. In this case, we define a liquidity trap as a situation in which private investment stagnates despite the readjustment of the structure of production. One such situation of this occurring was during the Great Depression. This topic is tackled by Robert Higgs, in which he attaches the blame to "regime uncertainty," or uncertainty caused by a general antibusiness climate produced by the government.[58]”

- The policy uncertainty argument always seems odd to me. Empirical evidence suggests that the policy uncertainty is of minimal concern to businesses relative to other uncertainties (i.e. – demand uncertainty). The arguments of Higgs and others always strike me as a case of post hoc ergo propter hoc. The policy reacts to the business climate, not vice versa. This at least seems to be what we see in the business confidence data.

JFC: “Wealth-producing investment relies on two underlying factors: that there exists a demand for the product and that the producer can satisfy that demand at a profit or by receiving greater satisfaction in return. That government cannot satisfy another's demand at a profit can be extrapolated empirically, because if it could, there would be no need for deficit spending — the capital necessary to fund these programs would come from received profits.”

- I think this whole statement is problematic. I could probably agree with the first part of the definition – that there exists a demand for the product. I don’t see what profits have to do with it. What about a competitive situation where economic profits are driven to zero? What about non-profit institutions – do they not produce wealth? Profit seems to me to be important because it provides an incentive and information on consumer demand. It doesn’t seem to me to be definitionaly essential to wealth. I’m also having a hard time understanding what deficit spending has to do with it. Firms finance projects in a variety of ways – why should the government be any different? The share of government financing coming from debt can easily be explained by the unique qualities of the government – its status as a sovereign guarantor of currency, its longevity, etc. I really would have preferred that Jonathan defend this understanding of wealth more sufficiently.

JFC: “Fulfillment of satisfaction is dependent on individual subjective evaluations and voluntary exchange. Government, instead, distributes capital towards otherwise unwanted ends, taking it away from the private sector and "producing" at a net loss.”

- This seems to assume complete property rights. Otherwise, how else could Jonathan conclude that capital is moved to “unwanted” ends. Whether the ends that government moves capital towards are “unwanted” or not is indeterminate unless you are assuming complete property rights. Therefore, I’m forced to conclude that Jonathan is assuming complete property rights. It’s a bad assumption.

JFC: “The difference between Hayek and Krugman is that Hayek was not a utopian, and realized that economic growth can only once again take place if the structure of production adapts to society's time preference — there is no formula by which government can centrally plan wealth creation.”

- The non-utopianism is a quality of Hayek, but I don’t see how it is a point of difference between Hayek and Krugman. Hayek and Krugman are simply different kinds of non-utopian. Krugman certainly doesn’t believe there is a formula by which government can centrally plan wealth. They both think that there is a course which is closer to an ideal than an alternative course. If that belief alone is utopian, then they are both equally utopian – but I don’t think that simple belief is enough to qualify someone as a “utopian”.

I think one of the biggest liabilities of this piece is that it goes from a reasonably relevant Krugman v. Hayek discussion, to the liquidity trap, and then on to questions of deflation in general, ABCT, etc. I think the transition from the liquidity trap to deflation was perhaps appropriate given the important of inflation and deflation to Krugman's version of the liquidity trap, but I think it gets a little farther afield when it gets into the deflationary spiral - which it seems to me is quite different from the liquidity trap.

Part of the problem is that the liquidity trap is hard to incorporate into a theory like the Austrian School's, which for the most part doesn't incorporate anything like liquidity preference. Hayek's "loose joint" of money was the passage of time. For Keynes, the loose joint was more than that, and it came from liquidity preference (Garrison calls it a "broken joint" for Keynes - I think "looser joint" is probably more accurate). Without a well incorporated concept of liquidity preference, it's hard for Austrians to engage the liquidity trap. Policy uncertainty is invoked to explain what we see empirically and the concern with low rates and the capital structure is invoked to address the theoretical symptoms of the liquidity trap. But the real heart of it - the indifference between cash and bonds - is left completely untouched.

15 comments:

  1. I could see why a falling price level as a "solution" would result in re-equilibration. I don’t see how it addresses the fundamental dynamics of the deflationary spiral. The whole point of the deflationary spiral is that deflation further constricts the money supply, which causes more deflation. At some point, one may think that a real balances effect would put a brake on this. I am more persuaded by the idea that at some point the need to replace capital will put a brake on this. Either way – simply letting prices fall alone doesn’t seem to provide a solution to a problem that is caused by falling prices, unless you reject the logic of a deflationary spiral in the first place (which Jonathan doesn’t seem to).

    Guido Hulsmann answered this question in his lecture on deflation. As the deflationary spiral sets in, firms will have less income than normal and will presumably default on credit loans to banks. The banks, lacking income, will again default, and so on, where deflation results in further deflation. The point at which it stops is where all credit money (or most of it) is wiped out. The rest of the monetary base will be commodity money, or saved reserves held by banks. It's the entire inflationary structure of fractional reserve banking that is tumbling. Deflation is the removal of a previous inflation.

    Part of the problem is that the liquidity trap is hard to incorporate into a theory like the Austrian School's, which for the most part doesn't incorporate anything like liquidity preference

    Stop saying this. You are incorrect. Of course Austrians incorporate "liquidity preference" - how else could we explain deflationary spirals due to an increase in hoarded currency? The concept of demand for money is not lost on us. It's an integral part of explaining the mechanical workings of inflation, deflation, and credit money.

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  2. Jonathan M. F. CatalánAugust 1, 2010 at 8:34 PM

    It's hard to respond to it all, and I don't want to make the discussion too broad, so I will respond to some points. I hope to consolidate my thoughts on deflation in a future Mises Daily article, but I think Matthew pretty much covers it.

    In the article I listed three possible causes of monetary deflation (sorry to keep distinguishing between monetary and price, but by now it's ingrained in the way I think). I don't think falling prices will do much in regards to an increase in demand for money if this is caused by increased uncertainty. In this case, I think I agree with Selgin and Friedman that the best response is maintaining monetary equilibrium (Friedman supported this through the central bank, while Selgin supports a more flexible system through free banking).

    So, in regards to price deflation, I think the relevant cause is an increase in the default rate of loans. This occurs for two major reasons:

    1. Malinvestment.
    2. Loss in profit.

    The first cannot be aided. Malinvestment is malinvestment, and must be liquidated. The second is aided through a fall in prices. The problem, of course, is the assumption that all prices will fall immediately. While I don't really support the idea of "sticky" prices to the degree that many Keynesians do, I recognize that prices will not fall to the necessary level just because the economy needs to adjust. Prices will fall as individuals see fit to decrease the price of their product.

    As such, the end of the deflationary "spiral" would necessarily be where prices represent some point near an equilibrium, where profits are restored sufficiently enough to pay for debt.

    Of course, the other method of allowing this to occur is monetary inflation and try to approach equilibrium from that direction, but obviously to an Austrian this is inferior because:

    1. Distorts the structure of production.
    2. Tax on wealth.

    And, of course, the liquidity trap is another problem.

    In regards to "regime uncertainty", I mentioned in the article that currently that should have little effect, as one cannot really compare Obama to Roosevelt, yet. On the other hand, I do stress the importance of the uncertainty caused by the recession itself. I do think that regime uncertainty is relevant though, at least during the duration of the "recovery". Regime uncertainty, in Higgs' thesis, for example, had more to do with the period between 1933-1939 than 1929-1932.

    Finally, regarding bonds, maybe I was unclear, but of course it has to with interest rates. The interest rate, or the profit you make off the bond, is what covers the risk. I thought this was implied.

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  3. In this case, I think I agree with Selgin and Friedman that the best response is maintaining monetary equilibrium

    Ooh, you and I are going to have some fun talks on free banking vs 100% reserves.

    Excellent points elsewhere though.

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  4. Jonathan M. F. CatalánAugust 1, 2010 at 9:01 PM

    Not to start a debate on monetary theory here, but my point of revelation came when I re-read part of de Soto's treatise on money. He admits that an increase in demand for money that is not in turn lent and investment (or kept in circulation) will lead to monetary deflation. He just says that this is more desirable than monetary inflation, so is an evil we have to put up with.

    So, de Soto is just unwilling to concede to monetary equilibrium. I still have to finish Selgin's book, though.

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  5. 1. OK, but that's tantamount to saying "let the deflationary spiral run its course". That's fine if that's your position, but deflation in the case isn't a stable solution to anything.

    2. You were the one that shared with me Hazlit's "debunking" of liquidity preference! Garrison certainly doesn't see it as a part of ABCT. And if Garrison is a reasonable communicator of Hayek, then Hayek doesn't either. Austrians regularly mock the idea "savings leakages", which is just a "crude Keynesian" way of saying "liquidity preference". You might give lip service to hoarding, but there's nothing in the Austrian School that accomodates liquidity preference as a determinant of the rate of interest or of output.

    Lip service is cheap. Keynes talks about the impact of the rate of interest on the capital structure and the roundaboutness of production. He uses Bohm-Bawerk's terminology here - he talks about the roundaboutness of production and he essentially affirms the Austrian point. But that's lip service. It's a brief mention in the General Theory. I'd never claim that that's part of the Keynesian vision. Liquidity preference is the same way. If they really treated it as thoroughly as it needs to be treated, what exactly would be the difference between Keynesianism and the Austrian School?

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  6. *Aha - more discussion. That was a response to Mattheus's first point. I started typing and then left for the store.

    I'm going to read the rest of this tomorrow.

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  7. Jonathan M. F. CatalánAugust 1, 2010 at 9:25 PM

    Daniel,

    Keynes most certainly does not affirm Böhm-Bawerk's roundaboutness of production theory. In fact, Keynes calls it arbitrary. See Robert Murphy's dissertation on the theory of interest (criticism and defense of Böhm-Bawerk): http://homepages.nyu.edu/~rpm213/files/Dissertation.pdf. He discusses Keynes's criticism.

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  8. You were the one that shared with me Hazlit's "debunking" of liquidity preference!

    I shared with you Hazlitt's answer to the Keynesian notion of liquidity preference and its corollary effects. Not the entire renunciation of the notion of "demand for cash balances." Liquidity preference, in general, is of course accepted by Austrians (the idea that people hold money for various reasons). Hazlitt was refuting the idea that this elementary concept determines the rate of interest, or plays any enormous role in the realm of catallactics.

    Garrison certainly doesn't see it as a part of ABCT. And if Garrison is a reasonable communicator of Hayek, then Hayek doesn't either.

    Neither Garrison nor Hayek expend much effort talking about "liquidity preference" (I know this because I spoke to Garrison about liquidity preference not 3 days ago). It is not, and has never been, a central component of ABCT. Demand for money as a good is only relevant when we're discussing deflation or inflation.

    You might give lip service to hoarding, but there's nothing in the Austrian School that accomodates liquidity preference as a determinant of the rate of interest or of output.

    Of course we don't "accommodate" liquidity preference as a determinant of the rate of interest or output. That's a silly idea. Like I said, the Austrian view on demand for money is only relevant in an inflationary/deflationary circumstance. Our (I will take the majority of Austrians as 100% reservists) view on hoarding is that money is simply another type of investment and the demand for that investment is related to regime uncertainty and conditions that actors perceive to be deflationary or inflationary.

    The rate of interest is determined by time preference, risk premium, price premium, and entrepreneurial risk.

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  9. "The problem, of course, is the assumption that all prices will fall immediately." I dispute that assumption entirely. No one assumes that prices will fall "immediately," especially in times of uncertainty. If I'm not mistaken, the Austrian School prides itself on incorporating the element of TIME into its considerations much more so than the Neo-Classical School, a fact that makes many neo-classical equilibrium models, and their supposed implications, simplistic and problematic to say the least. I think that the point is that prices WILL ADJUST IN TIME, and that no one can know in advance precisely what that time will be nor can one predetermine some "optimal" timeframe within which that may occur. Price decreases, sure, aren't the only factor in changing liquidity preference, but they certainly ARE ALWAYS a factor.

    "While I don't really support the idea of 'sticky' prices to the degree that many Keynesians do, I recognize that prices will not fall to the necessary level just because the economy needs to adjust." That seems to be the flip side here. If prices don't adjust (and even then we're assuming no government interventions that could be hindering price adjustments and market clearing) "immediately," then they'll forever be "stuck" where they are. Sure, that's an extreme take and many Keynesians may object to it, but I think that it is often enough implicit in their arguments. Here, too, we are regarding the market too mechanistically, too abstractly, it seems to me, and ignoring the very real HUMAN agency in TIME here.

    "I recognize that prices will not fall to the necessary level just because the economy needs to adjust." It's not as if prices "owe" the economy anything. Is not the falling of prices indeed the very act of the economy adjusting?

    "Prices will fall as individuals see fit to decrease the price of their product." But then, yeah, exactly. That seems in contradiction to what you said right before, however.

    All that I'm saying is, that we need to consider (and perhaps we are and I'm just being dense, granted) large-scale hoarding is a very RATIONAL response, perhaps the only or most rational response, by individuals to a crisis event. Ultimately, liquidity preference is not the source of the problem; it is what has triggered/continues to trigger the level of liquidity preference that's the problem. So targeting liquidity preference per se seems misguided. And, you guys are heavyweights here, not me, but isn't liquidity preference really just an expression of time preference? That's how I've always viewed it. I could be completely wrong, but I don't see how (alongside what has already been mentioned about Austrian treatment of liquidity preference) liquidity preference isn't perfectly compatible with Austrian ideas. Just my two cents, and I welcome being shot down, because I really am an amateur compared to you guys, but, if anything, I want to better understand these ideas and determine whether my concerns here are due solely to my own ignorance. (P.S.: Thanks for the shout-out, Daniel! I'm quite honored.)

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  10. "I welcome being shot down, because I really am an amateur compared to you guys, but, if anything, I want to better understand these ideas and determine whether my concerns here are due solely to my own ignorance." I hate seeing crap like that written, and I can't believe I just wrote that crap. I feel like such a douche. I'm going to go eat a bagel.

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  11. Jonathan -
    Keynes most certainly does not affirm Böhm-Bawerk's roundaboutness of production theory. In fact, Keynes calls it arbitrary. See Robert Murphy's dissertation on the theory of interest

    Well yes, Keynes said that the roundaboutness of production is not a primary determinant of the interest rate. Murphy is right about that. Look at the very next page after the one Murphy cites - page 216 - Keynes goes through the process of the lengthening and shortening of the capital structure as the interest rate changes. Which is precisely what I said - that he talks about the impact of the rate of interest on the capital structure in exactly the same terms that the Austrians do. But that doesn't make him an Austrian theorist (and, as you point out, it doesn't mean his theory of interest is Austrian).

    Mattheus -
    "It is not, and has never been, a central component of ABCT. Demand for money as a good is only relevant when we're discussing deflation or inflation."

    I feel like you're making my case for me, man! Ummm - of course demand for money is involved in the determination of the value of money. And anyone that talks about demand for money is going to mention hoarding. But that doesn't constitute a theory of liquidity preference worked out to all its logical conclusions. I'm not saying such a theory is incompatible with the Austrian school - one of the things I try to make a point of a lot here is that it's quite compatible).

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  12. Mattheus, what I'm getting out of you is that the Austrians don't theorize or use liquidity preference as thoroughly as Kenyes did - which is my only point.

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  13. Barbarossa -
    I agree that there's absolutely no reason why liquidity preference couldn't be thoroughly incorporated into the Austrian theory if you take the essential elements of the Austrian theory to be the capital structure and malinvestments. If you're wedded to their theory of interest or any ideological proclivities, perhaps it would be harder.

    I think it's somewhat different from time preference, though. Think about a dollar you put in a savings account vs. a dollar you put in a CD. Often, people leave money in their savings accounts for a substantial period of time - as long or longer than you would in a CD. So what's the difference? Why is the premium paid on the CD? Liquidity. That's not to say time preference isn't still a factor in the determination of the rate of interest - it is. But they're two distinct things.

    As for targeting the problem - yes and no. First, we have to define what the problem is. I think it's pretty incontrovertible that the biggest contributor to the spike in liquidity preference was the financial crisis. Some may actually disagree with me on that and may prefer to cite something like regulatory or tax uncertainty. Anyway, insofar as addressing the source means fixing the finance industry, I'm all for that. But another important source, once a depression gets under way, is uncertainty about future demand. One way to address that source, of course, is to augment future demand. So I think Keynesians in general are more on the same page as you on this than you might suspect.

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  14. Jonathan M. F. CatalánAugust 2, 2010 at 10:56 AM

    Barbarossa,

    You misunderstand me. When talking about falling prices, my point is that a price adjustment to end the process of liquidation is not bound to occur with the same elegance we ascribe to it theoretically. In other words, there may be a period in time in which a fall in prices does not stop liquidation of what are otherwise good loans. The process is bound to be bumpy and imperfect.

    George Reisman believes that the time necessary for this to occur may be equal to the time necessary to rid the economy of all fiduciary media. I am not sure this is true, and it's a bit extreme. I would rather claim that the time necessary is equal to the time necessary to restore a profitably relationship between the price of outputs and the price of inputs.

    But, just like I think that prices may be subject to some "stickyness" (i.e. maybe a vendor doesn't think he immediately needs to drop prices; maybe he thinks the fall in demand is only very temporary), there will also be no fluidity in monetary deflation. In other words, the rate at which loans are defaulted on or paid back before all the money is invested is also subject to some "stickyness".

    In regards to that last sentence you quote, there is no contradiction at all. That is, in fact, the essence of my point. Price deflation occurs when individuals believe that they can no longer sell their product at a higher price. Or, more accurately, that they will reap higher benefits by selling at a lower price.

    Regarding your last paragraph, I am not talking about liquidity preference really.

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  15. People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.

    The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.

    - Ludwig von Mises

    I suggest you read chapter 19 of Human Action, especially sections 2 and on. http://mises.org/humanaction/chap19sec2.asp#[1]

    This should clear any notion of liquidity preference having anything at all to do with the rate of interest.

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