Saturday, March 30, 2013

Price distortions, Keynesians, and Austrians

Krugman on price distortions.

I've been saying this for a long time - that we know how prices aggregate decentralized information and our whole concern is that the price signals are distorted.

The lines in here on Austrians are funny and sadly often true. I do think there's a point to not tying them closely to the view that distortions are in the price of labor. Some say that (especially explanations of "what made the Great Depression "great"" that follow Rothbard, etc.. But Austrians really are quite directly concerned with interest rate distortions in a way that the others aren't. In that sense they're a lot like Keynesians.

[Side note to market monetarists - of course if an interest rate is distorted that means that there are distortions in money and credit too... don't take this to imply at all that I am saying that the interest rate channel is the only mechanism through which monetary policy operates]

There is of course a difference - Austrians think interest rates are too low and Keynesians think it's too high [or, to appease market monetarists that see red whenever we talk about interest rates, Austrians think money is too loose and Keynesians think money is too tight].

This is the heart of my argument in my forthcoming Critical Review article, which I think is a pretty damn decent piece of prose.

I had a conversation about this with Jeff Tucker and Troy Camplin the other day on facebook but didn't get a response to my concluding thought (perhaps they'll pick this post up). David Henderson was in the discussion too but I think he was skeptical of a lot of Tucker's claims. In response to their insistence that interest rates were below the market rate, I noted that both stories are plausible. The Fed absolutely could distort interest rates by keeping them too low. And you'd expect to see different things in each case.

If interest rates are too low you'd expect to see eager borrowers outnumber willing savers, and you'd expect a boom (indeed, an unsustainable boom according to Austrians).

If, on the other hand, interest rates were too high you'd expect to see cautious or unwilling borrowers - maybe even people who would have borrowed deciding to sit on cash instead. You would not expect a boom, you'd expect a slump.

Now you can invent stories to account for this (and indeed - the stories have been invented). Maybe Obama is just terrifying the investors that would have otherwise borrowed at these too-low interest rates. Another option is to jump ship and talk about structural problems in the labor market (what Krugman focuses on).

But these don't seem to accomplish the task if we accept how markets usually work. Certainly at first glance the evidence seems to be pointing to the fact that interest rates are too high and money is too tight right now. Any countervailing force to explain that away has to be really huge. It has to (1.) dampen all that unsustainable boom activity that's supposed to happen when the Fed keeps interest rates too low, and (2.) push us deeper into the worst depression in (most of our) memory.

What accomplishes that? Health reform? Please. A minimum wage hike on the eve of the recession?

This is grasping at straws and people need to come clean on that.


  1. Krugman: "What my side of the debate would call for, instead, is a reduction in the real interest rate, if possible, by raising expected inflation"

    Ok, good. So does Krugman support Sumner's NGDP level targeting plan?

    My take on the GMU Austrian/Free Banking solution:

    1. NGDP level targeting at 4% now
    2. End too big to fail
    3. End deposit insurance
    4. Allow Free Banking in steps (freeing up bank asset holdings, privatizing currency issue, allowing commerce/banking combos like Walmart starting a bank, etc.)

    Sumner in a rare nice mood to Free Banking:

    "we’ll abolish TBTF, as we’ll no longer fear that big bank failures will lead to recessions. And then we’ll abolish FDIC. And then we’ll allow free banking; after all, even if a few wildcat banks fail it won’t affect the macroeconomy. But it matters how you do this. Go to wildcat banking without first getting rid of deposit insurance and you end up like Iceland."

    I'm cool with this. What's the problem with this view? Do you at least support #1 and #2?

    1. As Murphy says, below, one side is comprised of idiots. You are not on the winning side.

      The problem with 1 thru 4 is that they have nothing to do with unemployment or its cause.

      Go read Keynes or Delong, not Krugman.

      Our problem continues because of our current account deficit. Krugman's solution cannot work, as long as we have current account deficits.

      DeLong, only a few days ago:

      The Future of the Euro: Lessons from History

      The 1919-1939 interwar period taught us four lessons:

      In order for the world economy to be prosperous, adjustment to macroeconomic disequilibrium needs to be undertaken by both "surplus" and "deficit" economies--not by "deficit" economies alone.

  2. Good post by Paul Krugman.

    "I've been saying this for a long time - that we know how prices aggregate decentralized information and our whole concern is that the price signals are distorted."

    I presume you read Hayek's famous article in the American Economic Review on knowledge for your ABCT article in the Critical Review, Daniel?

    Also, you told me earlier on that you did not cite Dr. Michael Emmett Brady's 2011 article in the International Journal of Applied Economics and Econometrics discussing the differences between Keynes's treatment of uncertainty and Hayek's treatment of uncertainty. While uncertainty isn't exactly the same thing as the issue of knowledge, I believe that the arguments in Dr. Brady's paper hold water.

    Although the fact may be that it's your article, at the end of the day, and it's up to you how to write it...I think it would have been better had you at least mentioned the issues of Keynes and Hayek's differing epistemologies and differing treatments of uncertainty by at least citing Dr. Brady's paper.

  3. We do have an unsustainable boom - it just happens to be focused in long treasuries and, to a lesser extent, the stock market.

  4. I would say the more sophisticated Austrian argument would be money is too tight and interest rates are too low. Thus, the importance of not conflating the two.

  5. The Austrian argument isn't necessarily that interest rates are too tight or too loose (though, this is the thrust of their business cycle theory), it is that interest rates should not be controlled by a central bank such that they can be either too tight or too loose. Austrians want the interest rates to be natural amongst the market, whatever the rate is in voluntary transactions should prevail.

    1. If whatever the rate is in voluntary transactions should prevail, what happens at the ZLB when rates should be negative?

    2. I would say that you're putting the cart before the horse.

    3. you answer is so typical of a "libertarian with an extremely lazy mind operating on bad faith" You have no answer so you play a word game worthy of Noam Chomsky

      You are pathetic

      if you had a meaningful "theory" it would explain how a recovery could occur when economic conditions are what is knows as the ZLB or, as I would prefer, How does one stop runaway liquidation? And, how does one stop a downward wage spiral. If wages weren't "stickly" how does our chasing China's tail stop?

  6. I actually liked this Krugman post a lot. Obviously I disagree strongly with it, but it shows that when he wants to, he can try to explain the two sides. He couldn't help himself by throwing in the "whatever" etc. commentary, just to make sure his readers knew who the idiots were in the debate, but this was a pretty sophisticated post. It's because of stuff like this that I continue to read him, despite (what I consider to be) extreme partisanship and hackery.

    1. 1. Bob, sorry, but the truth hurts. We do know who the idiots are in the debate. You see one every morning in the mirror.

      2. Krugman omits Keynes key insight. A deficit in the current account, financed by gov't borrowing, is a massive price distortion. Krugman is a master in never talking about his true contribution to this mess, his advocacy of "free trade," a gov't policy to send your job to China.

    2. Bob,
      I agree. This is one of my favorite Krugman posts in a long time.

    3. "You see one every morning in the mirror."

      How classy (and 4th grade-esque!) Thanks for adding nothing with your presence.

    4. John S,
      Where is Aaron Burr when we need him?

    5. I stopped at your "blog" to take a measure of your being—what Dan says—a "libertarian with an extremely lazy mind operating on bad faith."

      First, I found you calling the propaganda of Mercatus Center on freedom in the 50 states a "study." What a farce. Any one who has read the study can see that it is an "arbitrary weighting of different categories in order to simultaneously preserve libertarianism as a distinct brand and also preserve libertarianism's strong alliance with social conservatism." For example, Mercatus pays no attention to the very regressive taxes of the states it calls free. Nor does Mercatus consider the substantially higher real incomes of so called less free states or the significance of this chart

      What the map demonstrates is that critical masses of high-achieving students are most likely to be found in urban counties in southern New England (Massachusetts, Connecticut, Rhode Island), the Mid-Atlantic (New York, New Jersey, eastern Pennsylvania), southern Florida, and coastal California from the Bay Area to San Diego. The other critical masses are more scattered, but a person familiar with U.S. geography can pick out Chicago (especially), Houston, Dallas/Fort Worth, Atlanta, and some smaller cities. In short, if one's goal were to visit every county where one could gather at least 100 high achievers, one could concentrate entirely on a limited number of cities on the east and west coasts and a few cities in between

      At another place you were complaining abut UCLAs lack of parking, which you attributed to parking fees being too low, that parking needs a "market solution." Why is it too much to expect a university to have parking available for all its students, etc.?

      It only takes a moment to realize that what you actually want to do is exclude the poorest students from UCLA, given the lack of public transportation to the school, etc.


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