Austrian Business Cycle Theory Redux (long)

[Borodog]

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tl;dr: Artificial credit expansion causes the business cycle.

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tl/dr:
And how do you distinguish btw natural credit expansion and 'artificial?

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Printing money and making it available for loan is artificial. Producing in exchange for money and then making it available for loan is not artificial.

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But private banks and other firms can make loans and extend/expand credit greatly without printing money, no? Or are you calling that 'production?'

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If you're talking about FRB, that's artificial credit expansion, and it caused the business cycles of the 19th century. I never said, nor do the Austrians, that central banking causes business cycles, only artificial credit expansion.

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in fact government economic propagandists... do their damndest to set businessmen up with the belief that the low interest rates are the norm and that Fed manipulation of the economy

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This is really a silly strawman, and these assertions about 'propagandists' and loaded terms 'manipulation' are laughable if you are interested in having a discussion. Genius bizmen are so easily misled on top of that, huh? Wow.

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Why can't you actually address the theory instead of all this stupid bluster?

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from wiki - 'In Austrian theory, the proportion of consumption to saving or investment is determined by people's time preferences, which is the degree to which they prefer present to future satisfactions. Austrians believe the pure interest rate is determined by the time preferences of the individuals in society, and the final market rates of interest reflect the pure interest rate plus or minus entrepreneurial risk and purchasing power components....

Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rent, interest. Austrians conclude that, since time preferences have not changed, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. Capital goods industries will find that their investments have been in error; that what they thought profitable really fails ...'

Time preferences often/constantly change [i.e. the tradeoff btw FV and PV changes, or utility thereof], and can do so overnight if not sooner. Witness the CP market.

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The CP market??? You don't even know what the term's you're using mean. You think the time preference of entire societies changes over night for no reason? Good luck with that.

A) I don't think you read the OP.

B) I think you are randomly googling for criticisms of Austrian theory and quotes you don't even understand.

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Also, 'Austrian economists claim that, in the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time.'

This is a false assertion, as there are any number of free markets where errors cluster which have led to prices/assets getting overbid or oversold throughout history.

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This is either a misunderstanding or a deliberate misrepresentation. Austrians claim that there will be no clustering of errors across the entire economy, since you can only arrange to have entrepreneurs across all industries and sectors, with all their wildly different and varying market conditions and participants, at the same time and in the same manner be deceiving them all with the interest rate. There's nothing to prevent all the participants in the buggy whip industry from failing to predict the advent of the automobile, and no Austrian makes any such claim.

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Regardless, if you believe that such things will never happen, you have to prove it somehow rather than hand-waving that it is 'self-evident.'

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You are a total joke. You have yet to even ATTEMPT to address the argument presented in the OP. You haven't even read the OP. Instead you google and cut and paste snippets of text you don't even understand. You're embarrassing yourself.

[DcifrThs]

zygote,

you are dealing with abstractions to the point of obfuscating reality.

this paragraph sums it up for me and i'll take it point by point. i'll logically prove my initial point tomorrow or saturday.

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If the present level of enjoyment resides in current consumption, for example, then no one will bother putting forth any efforts to sacrifice and produce more efficiently for the future.

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this is patently wrong. time preference defines the rate at which people would be willing to forgo present consumption for future consumption. if they feel they can forgo present consumption for an unlikely but large gain in the future, they'll do that.

just because the "present level of enjoyment resides in the current level of consumption" doesn't mean individuals or companies won't take chances to invest for large gains in teh future even if the time preference says they shouldn't

in other words, risk/reward on aggregate does a poor job of explaining or predicting outlier events. and it is in these outlier events that the largest gains in society are made. history is punctuated by these massively impactful, unpredictable creations/inventions/events that "aggregate" economics and the time preferences you speak of do a very poor job explaining.

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Entrepreneurs in society get involved in production to attempt to satisfy some level of consumption demands, which are basically infinite.

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again, this statement is just wrong if you intended it like you wrote it. you have convinced yourself that this is so far from being wrong that you state it like it is obvious.

the best entrepreneurs (i suck at spelling) CREATE demands!!! they don't see a niche demand and fill it (though some do) no matter how deep that demand may be or may be projected to be, they flip the paradigm on its head and say "everybody will want a computer on their desk when i make it good enough and cheap enough for them...trust me, you'll see"

or "people will want to listen to a non-skipping digital version of the CD based Discman"

they say, "i don't see a demand for X, but i am very willing to bet that if i make X well, a massive demand for it will arise." the implication there is that the inventor can overcome the time preference by creating something of such large immediate value as to create demand where there was none before.

even if the time preference dictates that it may only be worth $200 for an individual with that time preference to purchase an ipod, the quality differential can make up for that and spur demand beyond the time preference.

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In order for sustainable productivity increases there must be some individuals in the past who forfeited consumption to make possible the new production process or old production maintenance.

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but the level of forfeited consumption need not be so large as to make a material difference in the aggregate. especially, if as i mentioned int eh examples above, the projected payoff is huge. in fact, to the individuals, this may not even be a forfeiture.

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If the current time preference and, therefore, savings does not enable sufficient property to become available for creating a new production process, any efforts to make these productions processes succeed will eventually end in failure.

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productivity and technology may only require small marginal increases in savings to produce large gains in productivity. you have not taken this into account.

i'll come back and prove my initial point (i.e. where i asked for a simple yes or no answer, to which you gave an encyclipedic response) later.

Barron

[CrushinFelt]

I just read through the OP. Something doesn't seem quite right. There's something either wrong with the cause and effect sequences, or something is missing.

Now that I think about it, maybe it's just the fact that I don't see the business cycle as a bad thing.

In fact, that's definitely it. Your brick-building example just doesn't work. It's actually monumentally terrible. It only looks at the short-term picture and doesn't give a proper example of what can really happen during a bubble.

If you look at the tech bubble around '99-'01, what do you see? Artificial lending that eventually turned into a recession?

Sure.

But the story doesn't stop there. In your brick example, it was "well, we didn't have enough bricks so now we're worse off in the future because we now only have 4 houses when we should have 5."

That flat-out ignores the infrastructure and R&D investments that can be made during a boom-cycle. Using the tech-bubble as an example, there's absolutely no way that all the fiber-optic cable that was laid all over the globe could have been accomplished by now without the tech-bubble. It would have taken an enormous pre-planned collaboration of savers all over the world to lend all that cash to one sector. The hyper-lending made it all happen in less than a decade. This applies to all sorts of other areas as well (microprocessor research, genetic research, cleaner fuels, etc.). There’s no chance that standard, hard-money lending could accomplish what the bubble did in such a short period of time.

“Yeah, but then after the bubble we had a 2-year recession.”

True, but so what? It was still an investment in the longer-run.

Short-run boom ---> near-future recession ---> future expansion

It’s hard to say where we would be if hard money was the way our markets worked now. But I don’t think I could possibly be convinced that we would have advanced as far as we have now by that means. There are definitely drawbacks (recessions), but it’s a sacrifice for the future, and likely a more productive future than hard-money lending could ever produce.

Cliff's Notes: Hyper lending leads to a recession (as was crudely portrayed in the OP), but after the recession the economy has made more progress than it could have without the credit bubble. Thus the business cycle is just a necessity of an economy that grows much faster than with hard-money lending.

[CrushinFelt]

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I just read through the OP. Something doesn't seem quite right. There's something either wrong with the cause and effect sequences, or something is missing.

Now that I think about it, maybe it's just the fact that I don't see the business cycle as a bad thing.

In fact, that's definitely it. Your brick-building example just doesn't work. It's actually monumentally terrible. It only looks at the short-term picture and doesn't give a proper example of what can really happen during a bubble.

If you look at the tech bubble around '99-'01, what do you see? Artificial lending that eventually turned into a recession?

Sure.

But the story doesn't stop there. In your brick example, it was "well, we didn't have enough bricks so now we're worse off in the future because we now only have 4 houses when we should have 5."

That flat-out ignores the infrastructure and R&D investments that can be made during a boom-cycle. Using the tech-bubble as an example, there's absolutely no way that all the fiber-optic cable that was laid all over the globe could have been accomplished by now without the tech-bubble. It would have taken an enormous pre-planned collaboration of savers all over the world to lend all that cash to one sector. The hyper-lending made it all happen in less than a decade. This applies to all sorts of other areas as well (microprocessor research, genetic research, cleaner fuels, etc.). There’s no chance that standard, hard-money lending could accomplish what the bubble did in such a short period of time.

“Yeah, but then after the bubble we had a 2-year recession.”

True, but so what? It was still an investment in the longer-run.

Short-run boom ---> near-future recession ---> future expansion

It’s hard to say where we would be if hard money was the way our markets worked now. But I don’t think I could possibly be convinced that we would have advanced as far as we have now by that means. There are definitely drawbacks (recessions), but it’s a sacrifice for the future, and likely a more productive future than hard-money lending could ever produce.

Cliff's Notes: Hyper lending leads to a recession (as was crudely portrayed in the OP), but after the recession the economy has made more progress than it could have without the credit bubble. Thus the business cycle is just a necessity of an economy that grows much faster than with hard-money lending.

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poty

[CrushinFelt]

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I just read through the OP. Something doesn't seem quite right. There's something either wrong with the cause and effect sequences, or something is missing.

Now that I think about it, maybe it's just the fact that I don't see the business cycle as a bad thing.

In fact, that's definitely it. Your brick-building example just doesn't work. It's actually monumentally terrible. It only looks at the short-term picture and doesn't give a proper example of what can really happen during a bubble.

If you look at the tech bubble around '99-'01, what do you see? Artificial lending that eventually turned into a recession?

Sure.

But the story doesn't stop there. In your brick example, it was "well, we didn't have enough bricks so now we're worse off in the future because we now only have 4 houses when we should have 5."

That flat-out ignores the infrastructure and R&D investments that can be made during a boom-cycle. Using the tech-bubble as an example, there's absolutely no way that all the fiber-optic cable that was laid all over the globe could have been accomplished by now without the tech-bubble. It would have taken an enormous pre-planned collaboration of savers all over the world to lend all that cash to one sector. The hyper-lending made it all happen in less than a decade. This applies to all sorts of other areas as well (microprocessor research, genetic research, cleaner fuels, etc.). There’s no chance that standard, hard-money lending could accomplish what the bubble did in such a short period of time.

“Yeah, but then after the bubble we had a 2-year recession.”

True, but so what? It was still an investment in the longer-run.

Short-run boom ---> near-future recession ---> future expansion

It’s hard to say where we would be if hard money was the way our markets worked now. But I don’t think I could possibly be convinced that we would have advanced as far as we have now by that means. There are definitely drawbacks (recessions), but it’s a sacrifice for the future, and likely a more productive future than hard-money lending could ever produce.

Cliff's Notes: Hyper lending leads to a recession (as was crudely portrayed in the OP), but after the recession the economy has made more progress than it could have without the credit bubble. Thus the business cycle is just a necessity of an economy that grows much faster than with hard-money lending.

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poty

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ty ty [img]/images/graemlins/smirk.gif[/img]

[tolbiny]

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I just read through the OP. Something doesn't seem quite right. There's something either wrong with the cause and effect sequences, or something is missing.

Now that I think about it, maybe it's just the fact that I don't see the business cycle as a bad thing.

In fact, that's definitely it. Your brick-building example just doesn't work. It's actually monumentally terrible. It only looks at the short-term picture and doesn't give a proper example of what can really happen during a bubble.

If you look at the tech bubble around '99-'01, what do you see? Artificial lending that eventually turned into a recession?

Sure.

But the story doesn't stop there. In your brick example, it was "well, we didn't have enough bricks so now we're worse off in the future because we now only have 4 houses when we should have 5."

That flat-out ignores the infrastructure and R&D investments that can be made during a boom-cycle. Using the tech-bubble as an example, there's absolutely no way that all the fiber-optic cable that was laid all over the globe could have been accomplished by now without the tech-bubble. It would have taken an enormous pre-planned collaboration of savers all over the world to lend all that cash to one sector. The hyper-lending made it all happen in less than a decade. This applies to all sorts of other areas as well (microprocessor research, genetic research, cleaner fuels, etc.). There’s no chance that standard, hard-money lending could accomplish what the bubble did in such a short period of time.

“Yeah, but then after the bubble we had a 2-year recession.”

True, but so what? It was still an investment in the longer-run.

Short-run boom ---> near-future recession ---> future expansion

It’s hard to say where we would be if hard money was the way our markets worked now. But I don’t think I could possibly be convinced that we would have advanced as far as we have now by that means. There are definitely drawbacks (recessions), but it’s a sacrifice for the future, and likely a more productive future than hard-money lending could ever produce.

Cliff's Notes: Hyper lending leads to a recession (as was crudely portrayed in the OP), but after the recession the economy has made more progress than it could have without the credit bubble. Thus the business cycle is just a necessity of an economy that grows much faster than with hard-money lending.

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This post is so good it deserves a medal.

[econophile]

borodog,

i think talking about different flavors of business cycle theories (real business cycle, keynsian, and the late attempt to combine keynsian and RBC) might be informative. since i really suck at macro, you could take this on if you feel like it.

[RR]

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borodog,

i think talking about different flavors of business cycle theories (real business cycle, keynsian, and the late attempt to combine keynsian and RBC) might be informative. since i really suck at macro, you could take this on if you feel like it.

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I think we should have an econ forum. I have been toying with going back for that PhD.

[iron81]

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I think we should have an econ forum. I have been toying with going back for that PhD.

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This is pretty much Politics minus the occasional campaign or current events thread.

[DcifrThs]

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let's first agree the point i was stating: it has to do with future consumption ability. i contend that investment in a passive portfolio to collect risk premia will deliver excess returns that will increase consumption ability in the future rather than just move that consumption (as a result of time preference) from the present to the future.
do you agree with that statement?


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There are somethings your analysis is missing. Im going to try only go over the things i think are relevant to this thread though.

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i'll now go through the logic of what i mean by consumption ability.

assume all factors of production, land labor capital are all fixed at time t.

Wt= wealth adjusted for purchasing power at time t (i.e. present value of all stocks, investments, houses etc...basically stuff you can borrow against in a pinch or if you really wanted to)

It= disposable income

Dt= discounted ability or desire to borrow to consume= e^(-(T-t)*rd) where rd= all inclusive time preference and borrowing ability/desire etc. and T= end of time period (pretty far out so we'll just call it effectively retirement)

let, C(t)= consumption ability = It + Wt*Dt

now assume there are 2 cases:

a) that 10% of wealth is invested in originary interest at rate i

b) that 10% of wealth is invested in equities at rate r

now lets look at some time t1>t.

a) E[Wt1]= (1+i)^(t1-t)*(1/10)*(Wt) + (9/10)*Wt

b) E[Wt1]= (1+r)^(t1-t)*(1/10)*(Wt) + (9/10)*Wt

here, we assume for simplification that ALL wealth not invested at i or r simply grows with inflation so purchasing power of that segment remains fixed.

now, we know that "i" is simply a time preference and can be approximated (simplistically) by the "risk free rate" or bank savings rates etc....for simplicity again, here it includes inflation expectations and some small amount of "entrepreneurial interest" for the default rate of the FDIC, the govt, and banks (i.e. i'll allow for no such ting as a risk free rate)j. otherwise, it is basically your "originary" interest (let me know if i'm misusing originary interest or time preference).

r, however, also includes the default rate AND a risk premium above the default rate on top of i.

so r= i + default premium + XR

where XR is the excess return of the equity portion of the investment ABOVE the default premium and above originary interest. XR must exist otherwise nobody would ivnest in equities since they'd be gambling for the sake of gambling. historically, this premium has been very high, however, it can be expected to be lower in the future but still persistant.

now, my WHOLE POINT is that, assuming disposable income stays constant, and all non-invested wealth stays at purchasing power,

C(t) under a) will be less than C(t) under b.

so [C(t1)b - C(t)b] - [C(t1)a - C(t)a] > 0

thus, we have CREATED the ability to consume in the future due to investments ABOVE the entreprenaurial rate of interest as the result of a risk premium so that in the future, more consumption can occur than can presently occur. AND, this extra consumption is more than the discounted consumption ability from the future. remember, i kept ALL factors of production fixed. simply choosing to invest in equities vs. originary interest yields that extra ability to consume in teh future.

thats what i'm saying.

now, i've included some endogenous things (like inflation) that should probably be treated as exogenous, but that is easy enough to deal with.

please point out where my logic is wrong and how it is possible that there is NOT extra consumption created by investments in things that transfer risk premia.

thanks,
Barron