So a while back I expressed interest in a much more rigorous empirical investigation of the elongation of the capital structure, using input-output tables produced by the Bureau of Economic Analysis. I think Austrian arguments about the elongation of the capital structure make good sense, and I think it would be nice to confirm that in the data. I thought of a major problem with the interpretation of this sort of results recently associated with the question of identifying a "natural" or equilibrium interest rate, and therefore a "natural" capital structure. Austrians say that interest rates during the boom are too low, distorting the capital structure and setting malinvestments up for the bust. After the bust, interest rates return to "normal" and the capital structure becomes less elongated (shedding jobs in the process). Keynesians suggest that interest rates during the boom are largely fine, and we have busts when shocks make interest rates too high. You can see the fundamental disagreement between the two arguments, but the data should look the same. I think an analysis of the capital structure of the sort that I talk about in the link would still be interesting. It would be good to know more about how substantial the shifts in the capital structure are. But assuming they are significant, what would the Austrian model predict? Long capital structure in the boom, shorter in the bust. What would the Keynesian model predict? Precisely the same thing - long capital structure in the boom, shorter in the bust. The only difference is in what is considered natural. Keynesians will say the boom was natural. Austrians will say the bust was. Looking deeper into the capital structure is not going to be able to arbitrate that one.
The question I had for Austrian readers is how they explain interest rate behavior in light of deficits and monetary expansion, which Krugman talks about here. I know there was some related discussion about inflation several months back. Many Austrians had predicted runaway inflation and had to eat their words when it didn't materialize. More circumspect Austrians criticized them for making those predictions in the first place, noting the role of interest on reserves and other factors that would have prevented runaway inflation. So the inflation question seems to have been settled amongst Austrians, but I'm not aware of the Austrian story on why massive deficits and lots of money printing hasn't raised interest rates. Keynesians have a very clear answer - we're in a liquidity trap. Or more generally speaking, interest rates clear two markets - the credit market and the money market - and its possible for disequilibrium to persist in one while equilibrium persists in another. I'm not quite sure how Austrians account for this. Can they account for it? How? Just curious and figured someone might have insight.
A New Front in My War Against Scott Sumner
3 hours ago