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« A Terminological Suggestion | Main | Creative Destruction - Two Tales in Four Pictures »


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I think you are confusing nominal and real distortions. The entire increase in the nominal quantity of money and credit doesn't reflect real malinvestment. When prices actually rise, the real supply of money and credit both decline to levels that reflect desired saving.


Ok, but then what do you need the triangles for? Once you understand the Crusoe analogy, you have the nub. Distorted structure of production requires retrenchment to return to sustainability. The only question is why the structure gets distorted, but what do triangles have to do with that?


To some extent I agree with you. Hayekian Triangles not clearly useful, in "The Pure Theory of Capital" Hayek abandoned them. Unfortunately what he replaced them with is even more difficult to understand.

However, the triangles can be used to explain how the distortion happens. Garrison does this. Also, for the situation where consumer goods output rises during the boom the triangles are clearer IMHO. As others have been pointing out, that situation is the normal situation.


A lower market interest rate, given the supply of saving and demand for investment results in a lower quantity of saving supplied. And that is an increase in spending on consumer spending.

I think that is the way to describe the scenario of "why pay higher interest rates to depositors for their savings when you can instead borrow from the central bank at a lower rate."

I think one error with the Austrian Business Cycle theory is that it starts with an evenly rotating economy, where everything is adjusted to a given interest rate, and then we add an interest rate too low for that equilibrium, and show unsustainability.

In the real world, where capital goods are being produced to aid in the production of consumer goods at various future dates, the notion that any interest rate will result in someting sustainable for the indefinite future is completely unrealistic.

Keeping the current flow of saving and investment balanced is just about all that can be expected.

The profitability of any given capital good is going to depend on both interest rates and spending on the particular consumer goods that capital good will help produce, sometimes indirectly. Entrepreneurs must gauge future demand for particular things. Even if we aggregate and worry about the demand for capital goods in general, it depends on consumption in general in the future, and that must be judged as well.

As Hayek began to focus more on the future, he began to see what Lachmann emphasized. You head towards Shackle and even.. Keynes. Read again the responses of Rothbard to all of this. Is it really persuasive? How much does the capital structure in an ERE tell us about the real world?

When you start to realize that the height of the Hayek triangle isn't now, but rather in the future, and that now we are at various points along the side for a whole series of triangles, you start to see that malinvestment should be no surprise.

There is a yield curve of interest rates. There are expectations of total consumption expenditure at various points in the future. And, of course, what counts for a particular capital good really, is what the entrpreneurs buying it in the near future expect about the slightly more distant future. But that depends on what they expect about the slightly more distant future, and finally, what consumption will be then. But really, only the set of particular consumer goods that the capital good in question can help produce.

When you begin to see that the natural interest rate should not be assumed to be unchanging, and that the purchase of capital goods today depends on expectations of interest rates in the future, expectations of the demands for particular things (which can be partly due to general patterns of the demand for consumer goods in general, then this notion that an excess supply of money has reduced the market interest rate and so the pattern of demand for capital goods is unsustainable begins to seem less obvious.

My response to this complication is to focus on the flow of saving and flow of investment. But that is really the flow of real expenditure related to the productive capacity of the economy now. That the "right" interest rate to keep saving and investment in balance will create a capital structure that is produce the desired amount of consumer goods at an entire series of future dates is.. unrealistic.

Thank you for asking this question directly. Comovement was what made me a Keynesian, that on the theory that Austrian economics claims to address the best it fails to explain an important behavior. I still see Austrian economics as a useful critique but this is without a doubt the strongest counter argument.


I have no doubt you do understand, but you said you were confused, and the only way to explain myself was to do so as I did. In the scenario I laid out, the Fed doesn't have to make the loans -- they just have to dictate the interbanking lending rate to create those distortions.

There is no "right" interest rate -- there are only market interest rates that adjust in response to the market, or distorted interest rates that do not adjust in response to the market, but rather adjust in response to the Fed or to the government. It is the distortions which cause the bubble and subsequent recession.

And when you say that, "A lower market interest rate, given the supply of saving and demand for investment results in a lower quantity of saving supplied. And that is an increase in spending on consumer spending." you in fact explain how, given ABCT, one can get comovement. A lower interest rate discourages saving and encourages spending. Thus, you get increased consumer spending. It just won't necessarily be in the bubble part of the economy. More, there is likely to be a situation where supply does outstrip demand, once enough of the misallocated capital becomes consumer goods. This is when the distortion becomes evident, and the bubble bursts.

Maybe the answer lies in international trade. During the boom we just saw, imports skyrocketed. The falsely valued assets made Americans look wealthier than they "really" were, increasing the demand abroad for dollars, enabling Americans to consume more at the expense of everyone else, who plowed the dollars right back into assets like mortgage-backed securities. So both consumption and production go up in America, because the rest of the world is comparatively going without, i.e., consuming a lot less than they could be. In other words, you won't find the depressed consumption in America. You'll find it in China, whose factory workers "enjoy" depressed wages and high inflation as they absorb the effects of American monetary excesses.

Josh S.

You can't do the open economy analysis in inconsistent parts.

There is no puzzle about comovements in the simplistic sense. In a growing economy consumption and saving go up all the time. The production of consumer and capital goods go up all the time.

The only co-movement issue is whether malinvestment involves both the production of consumer goods and capital goods going up more than they otherwise would, or whether it is that the production of consumer goods go up less than they otherise would and the production of capital goods go up more than they otherwise would.

Generally, the scarcity constraint requires that something go up less than it otherwise would, and something about intermediate goods, capital maintenance, or capital goods that are appropriate to aiding production of consumer goods in the relatively near future don't go up.

Now, when we look at parts of a market economy, there is no reason for the savings of people in a region to match investment in that region. There can be net capital inflows and outflows between regions.

Anyway, your argument would need to be that Chinese consumer expenditure grew less than it would have because of an excess supply of money created by the Fed. Further, the crisis then occurred when the Chinese began to spend more on consumer goods, catching up. I think the China example has to break down because of the interventions of the Chinese government.

By the way, I find it troubling to read accounts of the Austrian Business Cycle theory that have the flavor of an investment strategy. That all points to the gold bug connection. Buy gold, don't buy stocks and bonds. Why? Well, the Austrian business cycle theory predicts stocks and bonds will suffer losses. Observe--M3 or something has been goign up all this time. You might think your portfolio of stocks and bonds are save. But now, all of this must collapse and people will take big losses on financial assets. But gold will be safe.

To me, and I think most of the economists here, the focus is on the question of whether all, most, or many recessions involve a need to reallocate resources that were misallocated due to some kind of monetary change. At least to me, trying to suggest to anyone how they should invest their money in the process is a secondary concern. No, just not a concern at all.

Anyway, if you move from theory to what happened in the 2000s, and China and the like, well, China had a crawling peg with the dollar, and had nothing like a free market economy.

Your argument reads as follows to me. There was a big housing contruction boom in Nevada, and consumption in Nevada grew at remarkable rates. How can consumption in Nevada rise as well as consumption? Well, it is obvious. The new homes were funded by people who live outside of Nevada. And, this could occur even if there were no excess supply of money or even with a constant quantity of money. People outside of Nevada put their savings into Nevada.

Now, suppose all the money to fund these houses came from Nevada banks (which it didn't, but just suppose.) Does that mean that excess money creation in Nevada was at fault? No, perhaps people from outside of Nevada put their money into CDs in Nevada banks.

But suppose they didn't put their money into CDs in Nevada banks, but rather checking accounts? Then we would see an increase in the quantity of money created in Nevada (checkabe deposits) matched by massive loans to people buying houses in Nevada, and lots of contruction of Nevada houses.

But still, this could be people in the rest of the U.S. putting their saving into Nevada to fund all of these houses. If it turns out that many of the people buying the houses on credit can't pay for them and try to sell, then the prices of the houses go down, the Nevada banks are in trouble, and if it is bad enough, the people in the rest of the U.S. who put their savings into Nevada banks take a loss. Unless, of course, the banks are bailed out by the taxpayers or the depositors in the banks are bailed out by taxpayers, or the like.

If we see the U.S. as Nevada and China (and the rest of the world) as the rest of the U.S., the same thing can happen if we just focus on the U.S.

In fact, if the rest of the world saving grows faster than rest of the world investment, and foreigners invest excess saving into the U.S., we would expect this to expand both investment and consumption in the U.S.

In fact, it should lower the natural interest rate in the U.S., to equate total saving (foreign and domestic) with investment in the U.S. The decrease in the U.S. natural interest rate (really compared to what it would have been) should decrease quantity of saving supplied here and so raise consumption. And the quantity of investment demanded should rise.

If the investment mostly in single family homes based on hope of capital gains on unsustainable price increaces, then this malinvestment is going to generate losses. But it does not require any excess supply of money or any increase in the quantity of money at all.

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