Selgin on Bubbles, Busts, and Bad Dichotomies

Steven Horwitz

George Selgin has a great new post at Free Banking discussing why Austrian cycle theory and Monetarist explanations of booms and busts are not mutually exclusive, and why modern economists, including Scott Sumner, have been sucked into a false dichtomy:

Sumner basis his position, not merely on the claim that prices are more flexible upwards than downwards, but on a dichotomy erected in the literature on asset price movements, according to which upward movements are either sustainable consequences of improvements in economic "fundamentals," or are "bubbles" in the strict sense of the term, inflated by what Alan Greenspan called speculators' "irrational exuberance," and therefore capable of bursting at any time. Since monetary policy isn't the source of either improvements in economic fundamentals or outbreaks of irrational exuberance, the fundamentals-vs-bubbles dichotomy implies that monetary policy is never to blame for changes in real asset prices, whether those changes are sustainable or not. If the dichotomy is valid, Sumner, Friedman, and the rest of the "monetary policymakers shouldn't be concerned about booms" crowd are right, and the Austrians, Schwartz, Taylor, and others, including Obama and his advisors, who would hold the Fed responsible for avoiding booms, are full of baloney.

There's lots more great stuff there including a great extension of the drinking analogy that's often used to illustrate the Austrian cycle.  This is a must read.

UPDATE:  And Sumner responds.

Comments

[Barkley Rosser]

Anybody wishing to deny the existence of asset bubbles needs to explain how and why we have seen premia as high as 100% on closed-end funds where one can buy and sell the assets in the fund, with those premia suddenly collapsing at certain points in time. I note that normally most closed-end funds where the underlying assets are freely bought and sold have net asset values of a single digit discount, as tax and management fees tend to justify a fund value below the net value of the underlying assets. The only way one can justify a premium for a closed end fund of freely tradeable assets is if one expects the value of the fund to rise in the near future, that is, if one is in the middle of a speculative bubble.

[Roger McKinney]

I have mentioned before that I think the ABCT provides the skeletal structure for the business cycle while the other theories flesh out the details. In other words, the other theories are not causes of crises but descriptions of them.

BTW, check out Hayek's review of contemporary theories in his "Monetary Theory and the Trade Cycle." It was written in the 20's but seems very modern. Not much has changed. rdmckinney.blogspot.com