"A powerful point I had never seen before: Evan Soltas:The problem is that the Austrian position is that malinvestments occur in the boom, not the bust, so this point would actually militate in favor of the Austrians. The bust is allegedly the period where markets are corrected and malinvestments are liquidated. Austrians would expect investments in this period to be more sober-minded and longer lasting.
How to Think About Malinvestment: If the central bank holds interest rates artificially low, it can in fact induce malinvestment--the central bank is creating an incentive to invest in projects which have negative net present values…. That's a bad thing, and it's not "Austrian" to fear that. Nor is it the irrational response of a private sector to malinvest under those conditions…. But all else isn't equal…. [E]vidence that… NPV-related malinvestment is nothing to worry about comes from the fact that businesses founded during recessions are more likely to last and be successful… discrimination towards higher-NPV [projects] during recessions, not negative ones…"
Now Soltas is right that you hear a lot of Austrians (not all, actually) complaining that money is too loose right now, but that's out of fear that an unsustainable boom associated with malinvestments is going to develop. You hear less of that lately out of Austrians - and more monetary disequilibrium and market monetarism from them - precisely because this case is starting to look ridiculous. Where is the incipient unsustainable boom?
My read of the empirical literature on this (and there's a surprising amount of it, albeit of varying quality - I think I looked at twenty empirical studies for my forthcoming article - details on that below) is that the length of the capital structure (the principal metric along which capital gets malinvested that Austrians care about) is indeed pro-cyclical, as Austrians predict. There are two main problems, though:
1. I have no idea how significant the fluctuations in length of the production process are and I don't know anyone that has a good answer to this. I know how to assess whether a fluctuation in unemployment or GDP is "economically significant", as people say. Austrians need to do more work on precisely how to think about the economic significance of the fluctuations in the length of the production process, because so far it's mostly hand-waving.Both of these points are elaborated on in much more detail in an article on Hayek's business cycle theory that I have coming out in Critical Review, volume 25 nos. 3-4 later this year.
2. Austrians need to do a better job justifying why the relatively lengthened capital structure in booms is "too long" and not "just right" and why the relatively shorter capital structure in busts is "just right" and not "too short". In other words, I would have thought boom years are the "natural" years and bust years are the "unnatural" years. This seems like the obvious assumption. Everything is working during booms and it's not working and people are in a panic during busts. So Austrians need to better justify the logic of flipping that on its head. A Wicksellian way of putting this is why do you think we're hitting the natural rate during recessions and below it during booms?
UPDATE: Here's a draft of the article.
UPDATE 2: Doing some final edits last night before handing this back again to the editor, I found some funky sentences in the last section... so... proceed with caution. Or better yet don't read it and wait for the final version :)
Posts
Dude, you can't post a working-paper link?
ReplyDeleteI can work that up today - nothing posted online yet.
DeleteIt's in the update
DeleteThis is a pretty final version, although I'm working on some edits for Jeff now.
DeleteThanks, I shall read it forthwith.
DeleteI'm looking forward to your article in the special issue on F.A. Hayek in the Critical Review, Daniel Kuehn...whenever the people involved with the publication process of printing and what not stop being slowpokes!
ReplyDeleteAlthough it can be argued that ABCT doesn't really deal with the issue of ambiguity, that isn't so much of a problem for me anyway. I find their description to have a kernel of truth - it can be said that a monetary authority can make a policy error that contributes to a boom-and-bust situation.
Although I don't believe that things would always be the primary fault of a monetary authority, my understanding is that ABCT doesn't have a very good description for how to get an economy out of the bust.
ABCT to me at least, seems better viewed as a hypothesis of a particular scenario for how an economy goes into an boom and a bust, rather than a theory. (Unless I'm mistaken, the term "theory" involves a definition of an explanation that is more comprehensive and wider-ranging in explanation.)
Well this issue is coming out on time - the plan has always been late 2013. Sometimes the issues run late but there shouldn't be any problems.
DeleteFor #2, are you serious? The Austrian justification is pretty detailed. You just agree with it or you don't.
ReplyDeleteAnd, this is why I draw attention away from interest rates. ABCT doesn't predict that lowering the rate of interest will make businesses with lower rates of return profitable. What really matters in ABCT is the increase in credit and the change in relative prices. That's why I like modeling ABCT with a normal PPF curve: the boom represents a movement towards an unstable equilibrium point on the PPF, and the bust represents the movement back. It's a bad allocation of input.
They have a story about what plays out but I feel like there is much more detail on what they think than why they think it. Take out interest rates, talk in terms of credit, and use a PPF. That's your "what". What's the "why"? I know you can draw a picture of a PPF with a boom as an unsustainable period. I can too. But why should I think that that actually describes, say, the 1990s? I am less clear on that.
DeleteSo it's not a question of logic, it's a question of empirical evidence. Because, you write, "So Austrians need to better justify the logic of flipping that on its head." I think the logic is pretty clear. What you're asking is if any actual real world booms fit the description.
DeleteI'm happy to accept a logical "why" too but I think all we have is logical "whats"!
DeleteLet me put it this way - given a blank theoretical slate is the notion that the boom is normal and the bust abnormal plausible? Of course it is. Do the Austrians present a story where the opposite is the case? Yes they do. Do they provide logic that would lead someone to reject the notion that the boom is normal? Not that I'm aware of.
I can tell the story that God created the earth in 7 days, 6,000 years ago. But that story is not a theoretical reason to accept creationism. The theory would have to be an argument that would have the story as it's logical result: the why that leads us to the what.
If ABCT has a well developed example of this I'm relatively unfamiliar with it (or else I am familiar with it but it is sufficiently underdeveloped that I didn't recognize it as such).
This doesn't make any sense to me,
Delete"Do they provide logic that would lead someone to reject the notion that the boom is normal? Not that I'm aware of."
If Austrians present logic that booms are not normal, then by definition booms can't be normal within the Austrian framework. And Austrians do have a logical, theoretical foundation for that belief. What you're arguing is that ABCT begs the question: it assumes its own conclusion. But, this isn't the case.
"Let me put it this way - given a blank theoretical slate is the notion that the boom is normal and the bust abnormal plausible? Of course it is. Do the Austrians present a story where the opposite is the case? Yes they do."
DeleteDon't Austrians believe that the boom and the bust are BOTH abnormal?
Does your definition of normal include sustainability? I can't see how the recent boom could have been sustainable.
Just to make sure Daniel is reminded yet again, low interests do not mean loose money. It is perfectly possible to believe interest rates are too low and money is too tight.
ReplyDeleteOf course. What makes you think I need reminding? This is the centerpiece of my discussion of the empirical literature!
DeleteI don't even see any casual statement in my post that could have prompted this... whatcha gettin at?
DeleteEvan: "So if all else is equal, Summers is right: If the central bank holds interest rates artificially low, it can in fact induce malinvestment -- the central bank is creating an incentive to invest in projects which have negative net present values at normal interest rates."
DeleteDaniel: "Now Soltas is right that you hear a lot of Austrians (not all, actually) complaining that money is too loose right now, but that's out of fear that an unsustainable boom associated with malinvestments is going to develop."
Just to make sure you weren't referring to a pat of the article not quoted, I read the actual article and nowhere does he even say the word and there is no mention anywhere as to the hardness or softness of money. Your sentence should read "Now Soltas is right that you hear a lot of Austrians (not all, actually) complaining that interest rates are too low."
To clarify: low interest rates are bad because they induce malinvestment, hard money is bad because it prevents any investment. If you have low interest rates and hard money ("we" really should talk more about these being the same thing - Happy Birthday, Milton), you get malinvestment and low investment and are doubly screwed.
To your actual point about Austrians complaining about loose money: you, and Krugman and others, keep saying this without proof. I know A LOT of Austrians who are complaining about low interest rates but not a single one complaining Nominal GDP growth is too rapid.
"artificially low" implies "below the natural rate" i.e., "loose money". Do you think he means something different by "artificially low"?
DeleteHardness or softness of money is completely different from looseness or tightness of money, btw.
I agree - I haven't heard anyone talking about NGDP growth that's too rapid.
Yeah, sorry about that, I meant looseness or tightness. (I'm not sure how an edit button would work without a profile, but if you could make that happen somehow, that would be awesome)
DeleteIf Evan meant "loose money" when he said "artificially low interest rates," I just lost a lot of respect for him. However, given that Evan has regularly endorsed both Sumner's point that interest rates don't tell you very much about the stance of monetary policy and the believe that looser money would raise interest rates right now, I doubt that is what he meant. I find it difficult to imagine that he would believe that something can be made "more artificially low" and "higher" at the same time. I would agree "artificially low" implies "below the natural rate," but interest rates below the natural rate mean that money is (has been) too tight, not that money is (has been) too loose. We have known this for almost 15 years.
Lastly, if you accept that no Austrian (or anyone else, really) is saying money is too loose, please stop saying that they are doing so.
Interest rates below the natural rate may or may not indicate that monetary policy has been too tight - it all depends on why they're below the natural rate. It is "loose" but that may be OK if there's an output gap you're closing. I think you are confusing this point about the relation to the natural rate with the point that low interest rates (although perhaps rates that are higher than the natural rate!) are generally a sign that money has been tight.
Deletere: "Lastly, if you accept that no Austrian (or anyone else, really) is saying money is too loose, please stop saying that they are doing so."
What are you talking about? Lots of Austrians say money is too loose. I'll continue to say they're saying that.
You've gone around and around on this enough that it's clear you're coming from Sumner's perspective. If that's the case then you need to understand that most of this is semantics and you shouldn't be running around accusing people of not understanding that the level of interest rates is not the same thing as the tightness or looseness of policy.
DeleteSome people do genuinely make this mistake. Evan doesn't and I don't, but I bet you fifty bucks the Wikipedia page on "monetary policy" does. So it goes.
Now, if we set those people aside for a second there are two groups of people: most people who think in Wicksellian terms, and a small amount of people who think in Sumnerian terms.
The Wicksellians say that what determines the stance of monetary policy is the relation of the interest rate to the natural rate. You can have situations like right now where the interest rate is quite low, but it's high relative to the natural rate and so monetary policy is tight. We would like to have looser policy to close the gaping output gap.
Then there is this small cadre of Sumnerians who mash up the Wicksellian point with the NGDP point. This, I think, is a bizarre way to talk about things particularly if the degree of efficacy of monetary policy is an open question. It amounts to determining whether we've taken an action based on whether that action was successful, which is pretty stupid IMO.
If you want to make the case for talking like this, fine. But don't accuse a Wicksellian of not understanding that interest rates alone can indicate the stance of monetary policy. It makes you look like you don't understand the nature of the conversation.
I haven't read Daniel's Critical Review article yet, but I'll just mention a few things....
ReplyDeleteThe ABCT argument isn't that during every "boom" the market rate of interest is below the natural rate. There's the case of normal growth where that isn't true. So, booms are often "normal".
One of the difficulties here is what we expect the level of roundaboutness to do in the long run. Is the long run trend increasing or decreasing? It seems likely, though not certain, that it will generally increase. It may be that during booms, especially the normal sort where the market rate of interest is above the natural rate, that trend takes over.
Unlike Soltas we don't usually worry about investments that have negative NPV. That's unlikely to occur. The problem is investments that have only a small positive NPV that become unprofitable to fund when the real interest rate rises.
Lastly, the difficulty I've always had with all this is that there isn't really one ABCT theory, there are many closely related theories. That's why I'm trying to classify them.
IMO, it's not that there are many competing variations of ABCT, it's that we've simplified the story, and overtime variations have developed on this simplification, rather than on the complete theory. I've always asked why modern Austrians prefer Prices and Production to the Pure Theory of Capital, and it's because the former is easier -- but, it's also relatively incomplete.
DeleteI agree with you about that, to some extent. There are some real differences though, with the Cantillon effect, the demand for money, and the role of interest rates. Anyway, it's not something I can talk about without using far too many words at this stage.
DeleteHey, I've been bitching about inverse malinvestment problems for a while now, haven't I? I did this before market monetarism was a thing! http://increasingmu.wordpress.com/2011/06/23/an-austrian-case-for-qe2/
ReplyDeleteI've read most of the article. It is well written and you offered a lot of counter arguments.
ReplyDeletePage 12 has a repeated word: "theory theory".
If Cowen is saying that "co-movement" can not occur in a "boom", he is wrong.
You write in the article:
"For at least two reasons, Hayek’s theory predicts that investment and consumption should move in opposite directions over the business cycle, with investment increasing in the boom and decreasing in the bust. "
I and C only move in opposite directions in a normal functioning economy, not in the boom/bust of the ABCT. In a boom, investors invest more due to lower interest rates AND consumers consume more because saving is less attractive due to lower interest rates. They are able to do this due to monetary expansion. As a result, the ratio stays more or less the same, but the sum of the two goes outside the PPF, which is an unsustainable situation.
This is one of Garrison's key points. There is no trade-off occurring, which results in a disequilibrium situation in which a wedge is driven between consumption and investment.
Edit... If Cowen is saying that according to Austrians, co-movement....
DeleteThanks for the thoughts. I know this is Garrison's position. Cowen's point is that Garrison is (1.) quite different from Hayek and that (2.) Garrison doesn't really make sense given what we know about capital consumption, capital maintenance, etc. I tend to agree with him. I think I make clear that there is a difference of opinion because though I argue Hayek's theory does not predict co-movement I talk at length about the fact that Garrison's does. So hopefully that's clear but I'll double check.
DeleteAs far as I can remember, Hayek's theory after "Price & Production" (in "Profits, Interest & Investment" and in "The Pure Theory of Capital") predicts co-movement in some cases. This co-movement isn't the same as Garrison's co-movement though, it's more about the period of recovery.
DeleteThis depiction of Garrison: "...by assuming that capital intensive production processes are more productive than labor intensive production processes, so the move to capital intensive processes can accommodate a simultaneous increase in consumption and investment." sounds to me like his explanation for growth when things are going right, not how things happen during a boom period.
DeleteAnyway, it's neat to get insights of the perspectives of other economists by your comparison to the economist I'm most familiar with.
Current wrote: "This co-movement isn't the same as Garrison's co-movement though, it's more about the period of recovery."
ReplyDeleteThanks for your insights. I'm going to have to re-read Hayek to prove to myself that he doesn't allow for co-movement during a boom.
The period of recovery should be similar to that of steady growth when things are right.
I'm going to have to go back an re-read it myself too. I last read it in ~2009. As far as I can remember though the "Pure Theory of Capital" especially comes to different conclusions about co-movement to "Price and Production".
DeleteI think that this is a good paper. However...
ReplyDeleteKuehn: Attempts to link findings on the capital structure to the business cycle have been considerably less satisfying, and have largely ignored (or improperly operationalized) Hayek’s view that a loose monetary stance (and not simply low interest rates) are required to make a boom unsustainable. The relationship between loose money and subsequent busts in the post-war United States is quite weak, though. As Friedman (1969, 1993) pointed out using other methods many years ago, there is a much stronger link between busts that are independently caused by tight money (and not by a preceding boom).
I believe that Hayek answered this in 1975 in the very first thing I ever heard him or anyone say on the subject of the Keynesian-induced boom/bust cycle:
Hayek: There are many bad effects of inflation, but the worst is that it draws LABOR* [emphasis added] into employments where they can be kept employed only by an accelerating inflation. And the point inevitably arises where inflation cannot be accelerated sufficiently fast to keep them in that inflation [I believe Hayek meant “employment”].
*and investment
Transcript:
http://mises.org/daily/3311
My recording:
http://mises.org/media/2773
“Loose money” is nothing but surreptitious theft of purchasing power from victims oblivious to the theft. “Loose money” fuels both the extravagant capital expenditures and extravagant consumer expenditures. Everyone thinks both they and society are richer than they really are. It will all come to an end either a) When the “loose money” gets tight; or B) Reality invariably sets in regardless of a tightening of the “loose money”.