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The usual mechanism for this sort of crowding out is higher interest rates. They do not exist. Banks apparently have money, but they are not lending to private businesses for a variety of reasons, most of them having to do with their existing piles of bad loans. I have seen zero evidence that one of those reasons is that they are worried about budget deficits. Got any evidence for that aside from amusing wisecracks about Bastiat clue sticks?

"The jobs that weren't created because the private sector lacked access to capital due to increases in government borrowing...."
In times of recession government borrowing DOES NOT crowd out private investment because private investment is simply not there. It has gone in search of safe, liquid assets. Resources are idle. The Treasury View all over again. Even after DeLong and Krugman blasted its modern proponents.....
So slap yourself with the Keynes stick

Both comments suggest there is no opportunity cost to government spending. Well, our problems are over because scarcity has been eliminated. Let us just spend our way into everlasting prosperity.

I'll pass on commenting on the hyperbole ("private investment is simply not there."). There are idle resources, but not all resources are idle. If some are scarce -- and the "no lending story" suggests capital is scarce -- then there is an opportunity cost to government spending.

Much of the federal spending is being used to bolster state budgets in order to maintain public employment at current wages. A disproportionate share of the adjustment in labor markets thereby falls on private-sector workers. Some gain at the expense of others. That is an opportunity cost.

Amity Shlaes has an excelelnt op ed in today's Journal on the serial failures of the New Deal. She explains how one intervention led to another until FDR finally abandoned the whole enterprise at the end of the 1930s (a fact ignored by modern-day New Dealers).

The real issue is that the bust reflects the fact that consumers' preferences are not matched by the structure of production. Government interventions, appart from inefficient and leading to rent seeking and extracting, prolong the misallocation of resources and the continuation and aggravation of the mismatch with consumers' underlying needs.

Barba nailed it - yes, resources are idle, but for good reason: they're in areas of malinvestment, areas that aren't aligned with consumer preferences. Throwing more good capital after bad (i.e. government creating jobs or preventing job losses in these unsustainable sectors) will simply destroy wealth and delay recovery.

But it sure makes for some good propaganda.


I think scarcity exists. That is why decreases in employment and production in nearly every sector of the economy is a problem and a puzzle.

Sure, if the government uses labor and other resources (not money) to producing things, then something else cannot be produced.

But unless prices and wages drop a lot, the current volume of nominal expenditure cannot purchase all that can be produced. And so, we can talk about sacrificing output that would be generated after prices and wages dropped enough so that some household or firm would purchase the goods or services.

And, of course, there is my preferred alternative of expanding the quantity of money. I don't think what you said about inflation quite expresses the situation where current prices might be above equilibrium.


This only works if there is a liquidity trap. There is no doubt that the Fed can fund government with newly created money. And maybe people will substitute government bonds for money and they won't even have to create more. But it doesn't really matter.

The question is, what is the alternative policy? Only in a liquidity trap is there no alternative policy.


There is investment now. The point is to create more. Or maybe more consumption.


Employing idle resources increases income. Since resources are scarce, idle resources are scarce. So, only a limited increase in government spending employing idle resources can increase income. Increasing government spending cannot increase income an unlimited amount.

To me, "capital" is things like machines, buildings and equipment. They are scarce. But many are idle. I don't think an unwillingness to lend has much to do with it. It seems to me like a confusion of credit and capital.

It is possible to argue that the current price level (and wage level) is keeping the real quantity of money equal to the demand to hold it and the real volume of expenditures equal to the productive capacity of the economy. The usual argument is that if this wasn't true, prices and wages would all be lower.

And since employment and output are low compared to both their peaks and their trends, it must be that the productive capacity of the economy has fallen and the natural unemployment rate is extra high.

If that is what you believe, why not say so? And then explain why.

In his EconTalk interview with Russ Roberts, Larry White mentioned some work by Mike Montgomery on Austrian capital theory. In a Review of Austrian Economics article in 2006, he presented a disaggregated capital theory (what, no K?) in which capital consists of "structures" and "equipment." Viewing it this way, or as "things like machines, building and equipment" overlooks inventories, which could include machines, etc., but will also include goods-in-process closer to consumers in the production structure, such as stuff on retailers' shelves. I think Montgomery chose his method because he found data that measured his two categories.

The WSJ the last day or two discussed some anecdotal evidence that investment by small businesses is turning up a bit. The Journal today also had an article on private merchant funding, and mentioned a company called On Deck Capital. These firms often get funding from hedge funds. Having said this, the evidence is pretty clear that for the last few quarters banks lent quite a bit less to small businesses than they had previously. Regime uncertainty played a role in their decision making, as well as the fact (related by a banker to me) that they perceived a downturn in profitable investment opportunities that matched a similar downturn in viable new investment plans presented by their customers.

jerry, if you admit that some resources are idle then you have to admit that, if you target those resources, government spending will not crowd out private spending.
you incur in hyperbole yourself when you say: "Well, our problems are over because scarcity has been eliminated. Let us just spend our way into everlasting prosperity."
of course we can't spend ourselves into prosperity, and scarcity has not been eliminated. but a recession is an abnormal event. talking about scarcity when refering to IDLE resources does not make much sense

brad delong says: "when short-term safe nominal interest rates are at their floor to make safe short-term bonds nearly perfect substitutes for cash, for then the standard mechanisms of monetary policy--flooding the system with cash and relying on the fact that holding wealth in cash is expensive (for it means that you forego interest) to trigger a rise in spending--is not guaranteed to work. And then fiscal policy has a place. To deny that fiscal policy has a place is then, it seems, to me, to fail the most basic test of thinking like an economist. As John Hicks put it back in 1937, we know that the speed at which people spend their cash--the velocity of money--is a function of the short-term safe nominal interest rate. And we know that the velocity of money becomes very elastic as the short-term safe nominal interest rate becomes very low and we have to resort to fiscal policy and banking policy--things that affect not the quantity of money but the flow-of-funds through financial markets."

do you beleive that that is a wrong analysis?


"The Federal Reserve yesterday released its January 2010 Senior Loan Officer Opinion Survey on Bank Lending Practices, which is based on responses from 55 domestic banks and 23 United States branches and agencies of foreign banks.

The survey found that, once again, “demand from both businesses and households for all major categories of loans weakened further, on net, over the past three months.”

Why? Businesses are still wary of making big investments. The Fed report says:

Almost all banks that reported weaker loan demand indicated that their customers’ financing needs for investment in plant or equipment had decreased as had needs to finance inventory and accounts receivable.

In other words, just increasing the supply of credit available to businesses won’t be enough to jump start lending. Businesses have to want that credit, too. "

so where's the crowding out????

Juan Carlos,

Government spending is consumption, as Murray Rothbard pointed out. The demand that is satisfied by such spending is not consumer demand, but the demand of politicians and government bureaucrats. (At least private criminals don't invoke high falutin' economic theory, the Keynesian multiplier and other nostrums when they spend "their" stolen loot.)
DeLong is wrong when he says that with interest rates on the floor, short-term government paper is a nearly prefect substitute for cash. You won't find any merchants who accept government debt in lieu of cash as payment. It would be easier to find some who accept gold, but you'll have to search far and wide for even one who would do so. Dunkin' Donuts posts signs saying they won't accept a Federal Reserve note in a denomination higher than $20.

I see no reason to accept Hicks's view that the velocity of money is a function of s-t safe nominal rates.

As for the Fed's Jan. 2010 report, that was based on data compiled last year and now we're two weeks from Valentine's Day. Markets can move a bit faster than they'd have you believe.

The Fed's view is rather institutionally, not to say politically, self-interested, as Jerry O'Driscoll and Alan Meltzer have pointed out.
Jerry had a good WSJ op-ed a couple weeks ago pointing out that banks were incentivized not to lend as much as they might have by certain Fed policies.

I guess I stirred things up.

I can't restate Austrian Business Cycle Theory in a blog posting. I presume it as background. That being said, I think that Guillermo Barba and Justin hit the nail on the head.

Beyond that, I will respond to what I preceive the major, interrelated issues. First, what is the source of income, employment and output? Spending (consumption) or saving? For classicals and Austrians, it is savings. For Keynesians, it is spending. That is the great divide in economics.

Second, not all factors are substitutes. Some factors are complementary and usable only in combination with others. If some compelmentary factors are scarce, then all the conclusions about the effects of spending are suspect.

Third, idle resources are not necessarily "wasted" and generally have some economic value. It is not costless to use them.

Fourth, circulating capital consists of current funds. Credit is one source (though must ultimately financed by savings) of current funds to an entrepreneur. It is a shortage of circulating capital that brings about "the Hayek moment" -- the crisis.

Fifth, as Martin Wolf recently observed, the biggest mistake one can make in macroeconomics is to confuse the trend and cycle. It is likely the trend rate of growth is lower than thought.

My sixth point relates to various posts made by Mario Rizzo at ThinkMarkets (including a recent on GDP statistics). A recession is not "an abnormal event," which suspends economic theory. A recession is a theoretical construct, not datum. It is word we use when the normal churn reaches an arbitrary point. The resource reallocations going on in a recession may be different in degree, but not in kind from what occurs every day in a market economy.

Finally, I must say that I did not use hyperbole. I employed irony with a tinge of sarcasm.

Most of the jobs created were also government jobs. Which means there was a money transfer, and a negative creation of wealth.

jerry, what would you say then is the main error of keynesian theory? failing to account for the heterogeneity of capital - and of labor?

and one more question, the austrian theory of business cycles seems to abstract money from the analysis. (basically capital is deployed to the wrong uses). do you think it is correct to exclude money from the analysis? to exclude for example the different financial assets and their different riskiness and liquidity?

I can't answer for Jerry, but I would say that's one of, if not THE, major error of Keynesian theory, especially when combined with its over-aggregation which "conceals the fundamental processes of change."

Recognizing the heterogeneity of capital means that when resources are idle, not just any old spending will activate them. It has to be on projects that can deploy complementary capital (and labor!) in profitable ways. The Austrian argument is that only individuals via the market can do this with any reliability.

I'm also not clear how money is "abstracted." The Austrian theory IS a monetary theory of the cycle: money is central to the story. The reason capital is deployed to the wrong uses is because excess supplies of money distorted interest rates that led to the malinvestment of capital. How does that exclude money? (And Lachmann explicitly discusses the role that money plays as a form of capital.)

Well, Steve, you do a fine job of answering for me. On all counts.

I can report that Hayek thought Keynes' fundamental error was the concept of aggregate demand. For Hayek, microeconomics is economics.

I will dealing with the monetary issues for this year's Cato monetary conference in D.C. on November 18th. The overall topic will deal with asset bubbles and should be of interest to the many who participate here on these issues.

Thanks all.

I was thinking of monetary analysis on something like these terms.

What is your opinion of an analysis on those terms? What is missing? What is irrelevant?


Funny you should bring up asset bubbles since many observers (myself included) think that the major trigger of this recession was the housing bubble and its crash. Was this the example of production not matching preferences and why did it happen? Now, I know some Austrians declare it all a matter of low interest rates in 2003-04, but the bubble started in 1998. Others say it is the Community Reinvestment Act, but Spain and Ireland and some other countries had bigger housing bubbles than we did without any such act.

Bill Woolsey,

Yes, I suppose this is partly a liquidity trap, although it does not look like people holding money so that they can jump into bonds or stocks at any moment. It looks more like what Juan Carlos reported from the Fed surveys: businesses afraid to borrow because business prospects look so lousy. Again, does not look like businesses are all panicked because of budget deficits. Indeed, the stock market bounced last March after Obama got his stimulus package passed.

Now, it may well be that public spending is less efficient than private spending, at least much of the time (although Troy Camplin's claim that all public spending means "negative creation of wealth" seems wildly overdone). Nevertheless, what the spending is on does matter. I am no fan of the old Keynesian "dig holes in the ground and fill them in" stuff. Let the public spending be on things with some use or value.

So, one area of the stimulus where I think we could use more is the bailing out of state level budgets. Sure, some of them are wasteful, but given that they face pretty hard budget balance rules and are facing sharply falling revenues due to the recession (or should we pretend that their falling revenues are all some misallocation relative to consumer preferences or some other phenomenon of "microecnomomics"?). In any case, most state level spending is on goods and services, many of which people seem to want such as education and highways and so on. Keeping states from arbitrarily cutting such things sharply (or raising taxes) strikes me as an at least less inefficient way to spend stimulus monies than some others.

DeLong responds:

Well, DeLong didn't call anyone an "ethics-free Republic hack" this time, but he did call "the Steve Horwitzes of the world" "mendacious[]" and "clueless idiot[s]." And, of course, he makes a complete travesty of Bastiat. A real piece of work that J. Bradford DeLong.


I don't think the housing bubble started in 1998, which was when housing prices started to firm up and then rise a bit. It would be like saying a stock market p/e of 17 (vs. a historical norm of 15) is a bubble. A market p/e
of 20 might be a bubble, 25 to be sure, but 17?
In any event, the Fed did cut rates at the time of the LTCM failure. Bubble aren't homogeneous one-size-fits-all events, and mapping interest rates and bubbles is probably not an exact science.
I followed the home building stocks closely during this period, and they weren't in bubble territory in 1998 even if they had risen a bit above their historical averages based on a couple of measures. They showed signs of a bubble by 2001-2002, but went on to trade at much higher multiples as the bubble developed in stages. Ditto for mortgage-backed securities. I am also a skeptic of the idea that the CRA was a causal force. Austrians (certainly Rothbard) have been critical of the idea that government spending has the same sort of cyclical effects that monetary policy does.
I guess it's one of two things I ever agreed with Krugman on.

DeLong is, to use the technical term, an asshole. Given the way he's treated people at his blog, myself included as he notes with his rehashing of my "Republican hackness," he's not worth responding to. But I'm sure PBS and my colleagues here thank him for driving up our traffic. :)

Wow - I am surprised by all the people here who believe in the basic Keynesian formulation that if some resources are idle at time t then government borrowing, investment and spending from time t+1 through time t+n must not crowd out private investment, and must generally be a good thing.

I would have thought that those with some familiarity with Austrian and other heterodox discussions of time, specificity of capital, and market responses to changes in supply and demand, would be more skeptical about such sweeping and unlikely propositions.

As some have pointed out, even if at time t there are "idle resources" this may be because real demand or supply has changed, or a bubble (possibly created by an intervention) has popped, and hence resources used in the bubble must now be reallocated to be used for something actually useful.

How can this be done without the benevolent and powerful hand of government? Well, leave it be a moment, the price of the capital will fall, and some private entrepreneur will see an opportunity - right? Isn't this how the market usually works?

Now, several people here have shown how the private sector can be crowded out at time t+2 or t+a or t+n even if resources were initially idle at time t or when government stepped in at time t+1 -- recall that Warren Buffett wanted to buy a bunch of the companies that government bailed out. If government didn't step in and pay a higher price, he would have got them at a steal. Prices were falling in many areas, setting up for a great flea market where private investors could have bought up the resources, the failing companies, chopped them up and reallocated the capital to better uses.

Instead government has been buying companies to "save" the jobs -- ie. freeze the resources in an inefficient use -- and the "stimulus" just like the bailout is feeding money into areas where government wants it to go, instead of allowing the failing firms to fail and get bought up and for the market to adjust.

You think that government is having no affect on the private sector? Think again. In many seen and unseen ways the spending is having immediate effects even before taxes have to be raised to pay for it--but that too is having an immediate effect as firms can see the tax hikes on the horizon.

For example:

"Owner optimism remains stuck at recession levels. The proximate cause is very weak consumer spending, better than a year ago, but that was pretty bad. … But the other major concern is the level of uncertainty being created by government, the usually source of uncertainty for the economy. The “turbulence” created when Congress is in session is often debilitating, this year being one of the worst. Themes including “tax more,” “tax the rich even more,” “VAT taxes,” higher energy costs due to Cap and Trade, mandates and taxes for health care, threats of “stimulus II,” incomprehensible deficits, and a huge pool of liquidity created by the Federal Reserve Bank that threatens price stability and higher interest rates. The list goes on and on. There is not much to look forward to here and good reason to “keep your powder dry.” Uncertainly is the enemy of the real economy as well as financial markets"

Small Business Economic Trends, National Federation of Independent Businesses, December 2009, at:

Notice the general reaction to the stimulus -- threats of “stimulus II,” it says, not "promise of stimulus II" and the same with the inflationary policy of the Fed. These businesses are not thinking "Great! Government is helping to increase the purchasing power of my customers, so that the proximate cause of lower consumer spending will subside" they are thinking "government spending on my competitors, on my suppliers, on boondoggles, is driving prices up and is ultimately going to cost me in higher taxes as well."

This is just the slimmest sliver of a taste of how these massive spending bills affect the private sector - recession or no recession.

And for Barkley:

1. THIS Austrian has never declared it "all" a matter of low interest rates, as several publications on the recession will demonstrate. Which Austrians were you referring to? Tom Woods' book does not declare it "all" a matter of monetary policy. A citation or two would be appreciated, otherwise that's a canard.

2. THIS Austrian has explicitly said, in print, that the role of the CRA was marginal/minor. The empirical evidence there is persuasive. Again, which Austrians are primarily blaming the CRA? Citation please.

Every Austrian analysis I've read has made the same basic argument, with differences in emphasis: the combination of Fed-driven low interest rates (negative real rates for a couple of years) and a variety of government housing policies (including the roles of F & F) that date back at least to the Clinton Administration, as well as things like land-use regulations, created a kind of perfect storm that led to a housing bubble and a variety of problematic financial instruments predicated on the rising prices associated with that bubble.

I have yet to read a piece by an Austrian that has seen print or really even on any of the major Austrian blogs that argues either of the positions you ascribe to unnamed Austrians. So if you have some, I'd like to have a citation. If not, then stop passing along canards.

Citations of my stuff: My contribution to the Kates volume:

The House that Uncle Sam Built:

Delong made some good points, but (a) he only named two ways that government can crowd out the private sector - for some reason thinking those are the only possible two, I am not sure why, and (b) he thinks he can measure whether those two are occurring - but how? He says there is no wage inflation, for example, how does he know? Isn't it not only possible but likely that wages would have fallen due to the crisis? That the "stimulus" and bailouts that have been "saving" jobs are quite obviously, in so doing, keeping wages where they were instead of letting them fall?

Talk about not-rocket-science it is quite obvious that this would follow. Supply and demand for labor, remember? Delong meet econ 101.


"Given the way [deLong has] treated people at his blog, myself included as he notes with his rehashing of my "Republican hackness," he's not worth responding to."

While DeLong might be an asshole, he has not dismissed your argument by claiming that you are an idiot. Rather, he's saying you are an idiot, because your argument is flawed. That is not an ad hominem argument.

Your refusal to respond to the substance of DeLong's argument is, however, very much an ad hominem. So, in terms of basic rhetorical points, we have DeLong 1, Horwitz 0.

Your move, Steve.

There will be no "move." I've tried to respond to him with civility, arguments, and evidence in the past (see our exchange over Hoover) only to have him hack up or delete my posts, deliberately altering their meaning, and engaging in more name-calling. No thank you. I have better things to do with my time than to respond to those who aren't interested in truth-seeking. Everyone gets the benefit of the doubt once, maybe twice, but he's violated the norms of civilized discussion too many times and with too many people for me to even bother.

He went after me by name. I'm choosing not to wrestle in his mud. Nor am I about to waste my time responding to him here. Folks here and at CafeHayek have already raised good responses to his argument. Go read those.

I have to agree with Rick. Steve, you really should respond to the DeLong. Push him on the heterogeneity of capital and labor for example. As far as I´ve read on his blog he dismisses that point just by saying that heterogeneity os hard to model. You could nail him there
This really is a debate worth having. For the sake of theory. For the sake of a better understanding of economics. The debate has gone on for too long. The issues are too important. Ignore the 'assholeness' and respond!

Rick Schaut,

The ad hominem is *in addition to* misconstruing Horwitz's argument (and Bastiat's). Indeed, if DeLong weren't in such a state of excitement calling people "idiots" and such like, he may have understood that Bastiat's argument is not based on a simplistic, straw-man notion of "crowding out." As "liberty" points out in this thread, a crucial element is time. Bastiat is not concerned with time t sub 0, he's concerned with the entire path from t sub 0 to t sub n. Moreover, as Jerry O'Driscoll points out, even with resources that are idle NOW, the opportunity costs of using them right now (eg. through "stimulus") is not zero. The national income equation can't account for this, of course.

And what's with the "Your move, Steve" talk? What is this, seventh grade? Good grief.

I've enjoyed your discussions here over anonymous postings and the role of shaming and ostracization. I think Boettke can put your non-move in his pocket as ammunition for future arguments. ;)

"Everyone gets the benefit of the doubt once, maybe twice, but he's violated the norms of civilized discussion too many times and with too many people for me to even bother."

Juan Carlos,

Those arguments have been made to DeLong ad nauseum and he deletes or distorts them. He is NOT open to persuasion, nor is most of his commentariat. If folks want to see the arguments, they can come here and read this thread. Feel free to go to DeLong's blog and post a link. It's all here.

I have a question: many models of international trade, including ricardo's comparative advantage model take labor and capital as homogeneous and derive the gains from trade from the fact that labor and capital can be reallocated to more productive uses.
Krugman writes, in a piece called 'Ricardo´s difficult idea' that:
"Wages are determined in a national labor market: The basic Ricardian model envisages a single factor, labor, which can move freely between industries. When one tries to talk about trade with laymen, however, one at least sometimes realizes that they do not think about things that way at all. They think about steelworkers, textile workers, and so on; there is no such thing as a national labor market. It does not occur to them that the wages earned in one industry are largely determined by the wages similar workers are earning in other industries"

What would austrian theory say about that? is ricardo's aggregation wrong? is his model, therefore, misleading?

@James and Steve, sorry guys, but you're not addressing DeLong's arguments. You're merely whining. Seventh grade, indeed.

The only person even trying to address DeLong's argument is libertyv. In this, however, libertyv's arguments fall short as well. First, if there are other, relevant ways in which crowding out can manifest itself, then, by all means, point them out. Draw the causal chains the same way DeLong does, and then show that these expected results are happening.

Second, your argument regarding wage inflation seems rather weak as well. True, there might be factors affecting wages apart from the effect of government spending that DeLong has posited, but what are they? You've cited examples that would have put upward pressure on wages, not downward pressure on wages.

It's worth noting that DeLong is pointing out that what we are seeing now is predicted by theoretical models. To merely poke holes at some of the assumptions behind those models is to relegate the Austrian school to just another one of the iconoclastic schools of thought that no longer, if they ever did, bring any theoretic value to the table.

And, perhaps, that's where the Austrian school belongs? After all, Europe has been on "the road to serfdom" since the end of WW II. I don't know vary many Europeans who think of themselves as serfs. Are they wrong, or has Hayek's prediction simply failed to come true?

It's funny how a blog post I wrote, which was limited to 500 words, for Nightly Business Report has somehow turned into the full academic statement of Austrian economics. It was a blog post for popular consumption, not intended for other academics and not written with the caution and "on the other hands" that I would write with for a different audience.

If DeLong seriously wants to grapple with Austrian ideas, then let him take on the more substantive treatments that are out there, rather than playing whack-a-mole with a 500 word blog post for the non-expert.

The problem, of course, is that every time he's been confronted with serious substantive arguments, he deletes and distorts them, so what exactly is the point? He has his little playground and he's welcome to it. He's shown no interest whatsoever in civilized dialogue on these issues.

You can call that whining if you want, but the reality is that the Austrian and similar arguments are out there (and here for that matter) for the critics to tackle, but instead he chooses to go off on a 500 word blog post. He doesn't want to take Austrians seriously, I'll return the favor.

Back to real work now.

don't underestimate the power of blogs to spread ideas and debate them seriously. isn´t it great that your post turned into "[a] full academic statement of Austrian economics."??

academics should be able to express their ideas in 500 words and make them understandable to a lay audience


Last time I asked you about circulating capital, you sent me to your "Economics as a Coordination Problem." Well, it was on my shelf and it has been sitting on my desk for some months now. I did read up on it and I still don't understand circulating capital.

I don't doubt that a higher price level reduces teh real quantity of money. If money is matched by credit, it reduces the real supply of credit. But trying to fit the reduced wililngness to lend over the last two years with that sort of story looks to be putting square pegs in round holes. I think it has to do with risk.

And of course, much of the decrease in lending is due to reduced demand for borrowing, which is due to low expected sales of products. That is the opposite of there not being enough circulating capital to go around, so excessively lenghthy projects fail so that the circulating capital can be used to fund more profitable shorter projects.

Malinvestment means that resources were used to produce goods worth less than the opportunity cost. Where are the opportunity costs? Where are tne alternative more profitable uses of resources?

We have the wrong capital goods? Why aren't new orders for the right capital goods expanding? What are the right capital goods supposed to be producing? There aren't enough of them? So, where are all of these industries with growing demand, higher prices, and higher profits?

Sure, when the Fed began to raise interest rates because of their fear of inflation, this plausibly popped the housing bubble. There wasn't enough credit to fund the housing bubble and everthing else.

But, the U.S. went into a "secondary deflation" in the fourth quarter of 2008, (and deflation is the wrong term really.) Nominal expenditure fell, not just below trend, but absolutely. The GDP deflator didn't fall really. And so real expenditures have fallen. Did productive capacity fall that amount? Maybe, but where are the shortages to match the surpluses?

I think there is still and excess demand for money, and financing government spending by money creation can expand output. It is just that there are better alternatives.

Juan Carlos - I totally agree. And getting across to a layman in 500 words was exactly the goal. But that's not the same thing as expressing the complexities and qualifications that are necessary for making the argument for an academic audience. Folks who confuse one for the other are not being fair.

Bill S.,

My view is that a journey begins when someone walks out their door and starts walking away from their house in a sustained way. Their neighbors seeing them walking down the street may think they are just going around the block when they are going across town.

So, I think a bubble begins when the sustained price movement away from the fundamental begins, which for housing was in 1998. Of course at the beginning it was not obviously a bubble, but arguing that there is some "bubble territory" that must be reached is arbitrary. What is that? You say 2000-01, but what about the anti-Fed junkie who says it was 2003-04 and hence "caused by the Fed"?

BTW, Charles Kindleberger always dated bubbles from the beginning of the price movement in Appendix B to his Manias, Panics, and Crashes.


Um, I said "some Austrians," and "others," not all. What is with all the capitalizing ("THIS Austrian" repeated)?

Regarding the all about interest rates, first of all I was referring specifically to the housing bubble, although obviously I think it was the major factor in the recession. Try Robert Murphy, Mark Thornton, F. Shostak, and I could name others, although I am sure that some of these allowed for some other elements. But Fed policy and low interest rates in 03-04 are clearly the Main Culprit.

As for the CRA, well fewer focus on that, although from time to time I see somebody here making that claim in the comments. Given that you dismiss it somewhat, I do not wish to embarrass anybody by mentioning names, but at the SDAE banquet over a year ago I spoke with someone who rather vigorously claimed that it was the change in policy "going back to Clinton" (as you put it) regarding the CRA that was the culprit. I won't name the guilty party.

Also, about a month ago when I was in a state that grows peaches I had a conversation with someone claiming to be an Austrian economist who identified the same item as the prime cause of the recession actually, along with Fed policy. Indeed, this person thought this is what students should be taught about the cause of the recession. But, again, I shall not mention any names.

Needless to say, I am fully aware that the label "ABCT" covers a lot of variablity, depending on if one is from inside or outside the Ringstrasse in Vienna, or is only just a provincial from Salzburg, Innsbruck, or Graz, or is even an outright barbarian hiding in the Vienna Woods hoping to catch Schumpeter pursuing some beautiful woman on horseback... :-).

I can't rehash ABCT in blog commentary. As Steve Horwitz remarked, the books are out there to be read.

I'll answer one question from Bill Woosely on circulating capital. It is the capital in the lowest stages of production, closest to final output. Wages and materials for completing a job (e.g., a residence) are the classic components. If you run out, you can't complete the project no matter how close to finished it might be.

In Hayek's classic formulation, there has been excessive investment in higher stages of production (malinvestment). Savinsg out of the income generated in the boom (bubble) is too low to finance compeltion of the projects.

The answers to the rest of Woolsey's questions are in the aforementioned literature.

I think I may be the "guilty party" from the SDAE banquet - and I am not ashamed at all but I do think my position (if it is mine in question) was a bit mischaracterized. I certainly would not say __it__ was the culprit, or any one policy was the culprit. One thing that bothered me during the heated discussions about the crisis at the time was that everyone seemed to expect you to name __one__culprit. That is just silly in my mind - it is generally the interaction of policies that leads to the worst kind of economic troubles.

Anyway, the position I put forth at the banquet - or intended to - was that the bubble (driven in part by monetary and in part by fiscal policy - f&f) was injected with a large dose of risk in the form of the price control known as CRA (and other related low income housing polcies). What this meant was that when the bubble popped - as was inevitable - many of the loans were worthless. Loans that should have been made at high interest rates because the borrower was a great risk had been made at very very low interest rates, because of the Fed policy and the CRA guidelines.

In addition, although the statistics make it look like CRA only affected a small portion of loans, digging deeper one finds that it and related policies (including FHA subsidized loans more broadly and the policies of F&F on what loans they would purchase) actually helped to set loan terms for a pretty large portion of first-time home mortgages.

Altogether, these CRA-type policies made the bubble much more volatile and destructive -- the loans that banks were stuck with when it popped had a much larger asset gap from the price paid for them. The crash was that much worse.

Steve, perhaps, for you, the opportunity cost of taking the time to put together even a wonkish blog post (with links perhaps?) on business cycle theory for the sake of people who understand basic concepts like calibration and structural variables, and to whom names like Prescott and Kydland are not unknown, is simply too high. That doesn't change the fact that DeLong's argument is rhetorically sound while your counter is not. That fact is likely to lead some of your readers to conclude that the opportunity cost of reading your blog is too high.


Do you normally play games with people who cheat? I don't. DeLong cheats. If I respond, even here, he'll distort the response for his own purposes. He's done it before.

You can hector me with this sort of thing all you want, but I will not respond to DeLong. Anyone who wants to read what I have to say about ABCT etc can find plenty of it here and elsewhere. Anyone who wants to read others on it can find plenty of that too. I wrote a whole great big book on Austrian macro that you can buy at Amazon in paperback.

And this is the end of my responses to you as well, as this meta-conversation has reached negative returns.


I think you well know that I have been writing about (and publishing on) speculative bubbles for quite a long time and am in fact the developer or innovater of certain ideas about them. I think you also know that I view most of them as being species of complex economic dynamics, and that also each one has its own peculiarities. I also fully accept that there are multiple elements entering into any given bubble, with not necessarily the same ones entering into all bubbles. The sorts of factors you mention I accept may be involved to varying degrees in this more recent housing bubble. I do not think I asked for anybody to propose a single culprit, indeed have complained when I have seen people appear to focus one one, which has sometimes appeared to occur around this blog (and no, I am not going to get into listing any further "guilty parties").

Quick recall:

"Given that you dismiss it somewhat, I do not wish to embarrass anybody by mentioning names, but at the SDAE banquet over a year ago I spoke with someone who rather vigorously claimed that it was the change in policy "going back to Clinton" (as you put it) regarding the CRA that was the culprit. I won't name the guilty party."
Posted by: Barkley Rosser | February 03, 2010 at 01:57 PM

"I think I may be the "guilty party" from the SDAE banquet - and I am not ashamed at all but I do think my position (if it is mine in question) was a bit mischaracterized. I certainly would not say __it__ was the culprit, or any one policy was the culprit. One thing that bothered me during the heated discussions about the crisis at the time was that everyone seemed to expect you to name __one__culprit. "
Posted by: liberty | February 03, 2010 at 02:46 PM

"I do not think I asked for anybody to propose a single culprit"
Posted by: Barkley Rosser | February 03, 2010 at 06:30 PM

--- ok, if you did not mean to say that any Austrian claimed the CRA "the one culprit" then what did you mean?

Steve, perhaps it's serendipitous that Rajiv Sethi posted this item today:

"Persuading a multitude of informed, thoughtful, intelligent readers of the relevance and validity of one's arguments using words rather than formal models is a far more challenging task than persuading one's own students or peers. If one can separate the wheat from the chaff, the reasoned argument from the noise, this process should result in a more dynamic and robust discipline in the long run."

It's entirely possible to respond to DeLong's argument without responding directly to DeLong at all. Doing so would contribute a reasoned argument to the discourse. Instead, you've chosen to merely contribute more noise.

Did you read Steve's follow-up post ("On the Unseen and the Unseeable")? This part may help:

"One final point: Sowell’s argument here can be read as another take on Bastiat’s “seen and unseen.” It’s not just that people can’t envision the unseen consequences of government policies, it’s also that the ways in which markets and civil society will evolve solutions to problems are themselves “unseeable.” The defender of markets is challenged on both ends: the costs of government intervention (e.g., the jobs not[] created due to the stimulus package, for any number of reasons) are hard to see because they never happen and the social benefits of markets and civil society are hard to specify in advance because the specific institutions that will deliver them haven’t appeared yet and the whole point of those decision-making processes is to discover them, which is something we currently do not and cannot know outside those very processes."

Maybe you could note what isn't clear here about the market process, which is a decision-making process, made by firms and individuals (not by aggregate variables in an equation). Also, are the epistemological issues here clear? Or do you see them as somehow confused? Maybe we could help on that point. But Brad's discussion of the Treasury market is not directly relevant to Bastiat's more subtle argument about the "unseen." What Brad is referring to can, as he gleefully pointed out, be seen. In fact, discussions of interest rates, elasticity, "slack" in the economy, etc. only distract from Bastiat's point about the "seen and unseen."

Also, it occurred to me later today that you may have never seen my posts on Brad's blog. (They were deleted sometime this morning.) But I tried to address some of these issues -- the epistemological one, the issue that Bastiat was NOT talking about "crowding out," but about interfering with the market discovery *process*, etc.

It's difficult to come up with concrete examples of what Bastiat (and Steve) are talking about -- because they are necessarily hypothetical. But consider the bailout of the auto-makers (and their finance units). Granted, some of the bondholders took a haircut, but the UAW took less of one than otherwise, most of the GM and Chrysler mgt stayed on, the brand names, corporate structures, corporate cultures, etc. stayed the same, AND GMAC has been propped up with tons of cash. In the absence of such a bailout (admittedly partial), some other company -- whether an auto company or not, may have come in and taken its place, especially with a cheaper workforce and fewer legacy liabilities. This would have also had effects on the auto parts suppliers as well. There was a great fear about wiping out a regional economy, if you remember. But without stretching the imagination much, you can see how a very different set of economic circumstances would have emerged in the wake of a GM and Chrysler liquidation, if it came to that. Absent a govt bailout or subsidy, whatever companies emerged in the aftermath would necessarily be profitable ones. Meanwhile, a company like GM (or it's capital structure, to be precise), which was demonstrably unprofitable, would be gone. Instead, billions upon billions of (borrowed) dollars have been used to prop up portions of the old capital structure, most notably the UAW, and -- depending on whom you ask -- the creditors. That new companies and uses for the various factors would not emerge *right now* or in this fiscal year does not gainsay the arguments we are all making on this point. As a father, I am particularly concerned about the period ten to fifteen years from now.

But precisely what companies would take GM's place, or where factors like labor, say, would be put to profitable use is impossible to say. I'm neither an entrepreneur nor an economic central planner, so I'd be hard pressed to come up with plans for what to do with laid off workers, idle plants, etc. But the market process *would* allow for the discovery of profitable uses for these factors. (Maybe you're concerned this would take too long, but how do you even begin to evaluate the costs/benefits of allowing this process to take place vs. using massive fiscal stimulus in order to make something entirely different happen?)

These are the types of scenarios that concerned Bastiat or that concern Steve, today, I think. I'm sure there are better examples, but does this not make sense? And does it not also make sense why the Treasury market today says nothing intelligible about the precise structure of the economy five years from now? It's not that Brad's points were necessarily poorly argued, but many of us have tried to explain why they're not relevant.

Rick Schaut,

DeLong's arguments are problematic at best; like my Keynesian macro profs in college, he puts far too much emphasis on the bond market, which is only part of the broader capital market.
He wonders why bond prices have remained so high (but doesn't call them for what they are--a bubble). It wasn't because the Fed targeted bond prices per se, but rather because it worked overtime to keep interest rates so low. The bottom line is that ceteris is not paribus here, which DeLong blitely ignores, as he does with so much empirical evidence that flies in the face of his comments.

I also can't resist rebutting your comment about his "rhetorical soundness," whatever that means. Rhetoric is neither sound nor unsound, unlike arguments. A sound argument is one that is logically valid and with premises that are true. An example is: 1. Joe is a dog. 2. All dogs are mortal. .:. Joe is mortal. The premises are true and the argument is logically valid, so it is also sound.
Here is one that isn't sound: 1. Fritz and Maynard are rappers. 2. All rappers are economists. .:. Frtiz and Maynard are economists. Now, Fritz and Maynard are rappers and economists, but the argument....


Um, maybe that someone arguing that there is a single (or leading) culprit might be their own doing and not me asking them to name one. Sheesh, play fair here.

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