Last week I guest-taught a class for my friend and colleague at GMU Dr. Colin Doran. The course was Introductory Macroeconomics and the lecture was on fiscal policy. The textbook is Paul Krugman and Robin Wells’ popular book Macroeconomics (5th ed). In the chapter on fiscal policy, after explaining its goals and implementation, Krugman & Wells discuss several common objections. They write (Page 386):
In practice, the use of fiscal policy—in particular, the use of expansionary fiscal
policy in the face of a recessionary gap—is often controversial….But for now, let’s quickly summarize the major points of the debate over expansionary fiscal policy, so we can understand when the critiques are justified and when they are not.
There are three main arguments against the use of expansionary fiscal policy.
• Government spending always crowds out private spending
• Government borrowing always crowds out private investment spending
• Government budget deficits lead to reduced private spending
The first of these claims is wrong in principle, but it has nonetheless played a
prominent role in public debates. The second is valid under some, but not all, circumstances. The third argument, although it raises some important issues, isn’t
a good reason to believe that expansionary fiscal policy doesn’t work.
This post will address Krugman’s & Wells’ (henceforth shortened to “Krugman”) claim that objections 1 & 2 are incorrect on principle; I will ignore point #3 for now. What follows will be a wonky discussion.
Following the above quotation, Krugman writes:
Claim 1: “Government Spending Always Crowds Out Private Spending”
Some claim that expansionary fiscal policy can never raise aggregate spending
and therefore can never raise aggregate income, with reasons that go something
like this: “Every dollar that the government spends is a dollar taken away from
the private sector. So any rise in government spending must be offset by an equal
fall in private spending.” In other words, every dollar spent by the government
crowds out, or displaces, a dollar of private spending.
But the statement is wrong because it assumes that resources in the economy
are always fully employed and, as a result, the aggregate income earned in the
economy is always a fixed sum—which isn’t true. In reality, whether or not
government spending crowds out private spending depends upon the state of
the economy. In particular, when the economy is suffering from a recessionary
gap, there are unemployed resources in the economy, and output, and therefore
income, is below its potential level. Expansionary fiscal policy during these
periods puts unemployed resources to work and generates higher spending and
higher income. Government spending crowds out private spending only when the
economy is operating at full employment. So the argument that expansionary fiscal
policy always crowds out private spending is wrong in principle.
Krugman’s statement isn’t objectionable, per se. But I do think critics of fiscal policy (myself among them) and Krugman are talking past each other. The discussion revolves around the Production Possibilities Frontier (source):
A quick recap: The Production Possibilities Frontier (PPF) is the various combinations of goods X and Y that can be produced in an economy at a given level of technology and resources. Any point along the curve (A or B in the above picture) is where all resources are consumed; therefore wanting to produce more of X would require some sacrifice of Y (and vice-versa). Any point inside the PPF (point C) indicates some resources are sitting idle and more production of X or Y could be obtained without necessarily sacrificing some of the other good. A point like D is impossible to obtain.
Krugman’s point in his above criticism is that if the economy is inside the PPF (Point C), that is to say, if the economy is in a recession, then government spending without any reduction in private spending. Since some resources in the economy (eg labor, capital) are sitting idle and not being used by private actors, they can be used by the government. These resources weren’t being used anyway, so their use by the government crowds nothing out.
The argument itself is quite solid on economic grounds, at least insofar as the PPF goes. However, I object on a more fundamental level. All goods are scarce and most goods are rival (that is, their consumption by one person precludes another from consuming the same). When the government increases its spending in a recession in order to employ the idle resources, it consumes resources that could have been used elsewhere. While the spending doesn’t crowd out current uses of resources, it does crowd out future uses of resources. If the government is employing idle construction workers to build bridges, for example, then it means that fewer construction workers to build potential office buildings in the coming period; any project takes time.
“But wait!” cries the hypothetical Krugman. “Those resources were idle. They weren’t building office buildings at all. What’s the harm in putting them to use building bridges?” This is a legitimate point, one to which I’d respond MR = MC. When the government employs resources, it necessarily bids up the price of using those resources (the government must bid on their use away from their current use, even if that use is sitting idle). In order for people to use those resources in the future, they must also be bid away from their current use, in this case, whatever the government is using them for. This would increase the marginal cost of whatever project those resources could be used for, which would mean the marginal revenue must also be higher before other people decide to bid for those resources. However, it may have been the case if the government never stepped in. The government spending might have, rather than ending a recession, caused it to persist by raising the cost of economic action.
Another question worth asking is even if government spending utilizes idle resources and we move back to the production possibilities frontier (points A or B), is the new allocation of X and Y optimal? Again, at the PPF, a production of more X necessarily means trading off Y. If the government spends resources to get the economy to Point A, where a relatively high amount of Y is produced and a relatively little amount of X is produced, but people prefer to be at B (more X and less Y), then couldn’t one argue that the government spending moves the economy to a point where things are less than optimal?
Consider a real-world example: World War 2. Prior to the US’ entry into the war, the country was in the Great Depression. Lots of resources were sitting idle. Once the war began, those resources (and then some) were poured into the war effort. Unemployment plummeted. Factory utilization skyrocketed. The United States became the Arsenal of Democracy as ships, planes, tanks, firearms, and munitions began pouring off the assembly lines. Across four continents, American armies and arms were engaged. But what of the homefront? People had to do without a lot of little luxuries. Rationing was huge. People had money but nothing to spend it on. Not what one generally thinks of when one thinks of a prosperous economy. The recession was technically over; we were back on the PPF, but were people better off (for a great discussion of this point, see Bob Higgs’ excellent 1992 article “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s“)?
To put the above story in terms of the diagram, let’s assume that Y is “war goods” and X is “literally everything else.” During the Depression, let’s say the economy is at Point C. After 1941, the economy moves to Point A. All resources are utilized but for the war effort. But if people prefer more X to Y, could we say this new state of affairs was better than the Depression? I’d argue “no.”
To be perfectly clear, I do not want to give the impression that Krugman does not understand the arguments put forth here. I do not think Krugman thinks scarcity doesn’t exist even in a recession or that there are still trade-offs. Keynesianism does not overthrow nor ignore scarcity. Rather, the point of this discussion was to provide some more detail into the criticism of fiscal policy and the crowding out effect. Crowding out still happens by virtue that all goods are scarce.
A Force for Good 
I think another part of the discussion must focus on the question of “what does ‘idle’ mean?” Is my rainy-day fund “idle”? How about my car repair fund? If you declare either fund “idle” and take it for other uses, that’s going to have an impact on my ability to deal with the rain or the car repair when it comes along.
And depending on the definition of “idle”, how much of Federal land should be taken away from the Federal government and returned to the States, or to the people?
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Jon, this is really excellent. Did you present this discussion in class to those Intro to Macro students? If you did, I suspect they had one of two very different reactions. One group will hope fervently that you never come back, and the other group will realize the low value of Macroeconomic and drop out of class. 🙂
The shortest possible rebuttal I can think of to Krugman’s presentation is a single acronym: ABCT (Austrian Business Cycle Theory). I think Krugman’s mistake is an expanded version of the Lump of Labor fallacy – in this case, a “lump of resources” fallacy.
In your example of government bridge building, those idle resources, including labor, that were previously occupied constructing office buildings can’t just be painlessly redirected to building bridges. The *reason* those resources are now idle, is because they were previously misallocated – almost certainly due to the obscuring effect of previous government fiscal and monetary policies.
Krugman’s failure, like that of many Keynesians, is the strange notion that government can somehow better direct the use of scarce resources than millions of individuals pursuing their own interests in a free market.
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Ron,
>—-“The shortest possible rebuttal I can think of to Krugman’s presentation is a single acronym: ABCT (Austrian Business Cycle Theory).”
Well yes, mercifully it does compensate with shortness for what it lacks in historical awareness. I feel like the Jewish mother-in-law whose complaint about the wedding was, “The food was terrible and the portions so small!”
ABCT requires a belief in the power of theory over evidence. And wouldn’t you know it, deep in the cults of ABCT is precisely where you can still find people arguing that economics is a deductive science that need not concern itself with awkward empirical facts.
Like it or not, in the post WWII period the U.S. has reacted to recessions with a Keynesian fiscal policy. During that period, the Great Recession was far and away the most severe economic contraction.
In a comparably long historical period between the beginning of the Civil War and the beginning of the Great Depression, this country had a fiscal policy that was much more relatively Austrian in nature. Recessions and depressions ran their course without much expectation that government should or could help. After WWII there was always a Keynesian policy response to a downturn even though no one followed Keynes advise long during the boom times.
So then let’s compare the results. Both periods had excellent long term growth that was the envy of the rest of the world. Both reached previously unapproached levels of prosperity and wealth. But only one of the two periods was plagued by horrible depressions and recessions.
According to Wikipedia, the first and relatively more Austrian era had SEVENTEEN recessions or depressions that were both longer and far worse than the very worst seen in the more Keynesian period. It’s going to take a lot of special pleading to account for that record and have ABCT survive the process. Which is precisely why you see so very few real world economists who don’t see it as about as well debunked as any economic theory ever has been in a discipline where no theory really ever dies.
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My two cents:
The ABCT needs work. The modern model, put forth by Roger Garrison, is incoherent and, frankly, impossible. Unfortunately, that task may fall to me because no one else seems to want to talk about that elephant in the room, but whatever.
That said, the insights of malinvestment are important I think.
Greg G may scoff at what I am about to say (but it’s ok, I love you anyway, man), but I think his criticism of ABCT and Austrian economics in general as a deductive science is a bit off. We need to be careful with metrics, as policy can become about manipulating those metrics rather than fostering genuine growth. For example, on paper, GDP during WWII exploded, unemployment was virtually non-existent, and production was sky-high. On paper, the Depression looked like it was over. In reality, standards of living fell (see my reference to Higgs above). By metrics, the Keynes stuff worked. By genuine growth, it failed.
I think there’s some interesting work to be done here: yes, there have been fewer depressions/recessions, but real wages have also stagnated and people claim the middle class is disappearing. Could the two be linked? Possibly. The Garrison model needs serious work. The role of recessions as part of a developing sustainable pattern of trade (a la Kling) should be explored. But I am no macroeconomist; those tasks may fall to others.
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Jon,
I am scoffing much more at Ron’s view of ABCT than yours (which is so much less enthusiastic in its endorsement). Of course malinvestment is real and has important effects. But that quite obvious and uncontroversial insight won’t begin to do the work that Austrians ask of it in supporting a theory of the business cycle.
I had no idea who Roger Garrison was but he was easy enough to find on line. I listened to one of his videos and it seemed to me he was claiming that Austrian policies are superior because they lead to the most sustainable growth path. He talks constantly about the sustainability of economic growth. Well hello! A recession or a depression is universally agreed to be a period when economic growth was NOT sustained. So why did the 70 year period of much more Austrian fiscal policy I referred to have all 17 of the worst recessions and depressions of the two periods? To say that the period of Keynesian fiscal policy had “fewer” is technically true but falls vastly short of the attention and explanation this glaring fact cries out for.
I agree that GDP numbers during WWII are not a valid measure of what we should mean by economic prosperity and I haven’t seen where Keynes advocated viewing the war years that way. Even though many economists calling themselves Keynesians expected the Great Depression to resume after the war as a result of sharply reduced government spending, Keynes himself never held that view. He was worried about inflation after he war and turned out to be prescient about that. In the Keynesian system inflation was thought to be incompatible with recession. That later turned out to be a weakness but the point is that, in the Keynesian system, the fiscal stimulus is viewed as igniting the recovery not being the thing in itself. And the post-war recovery did exceed all expectations.
As for your stagnation, disappearing middle class critique of Keynesian post war growth it didn’t feel like your heart was in it. On this issue I agree with Mark and Russ and Don that living standards have improved for everyone more than people realize in the last couple generations. And I suspect that you really do too. A poor person walking into an emergency room with with heart attack today gets far better care than the richest person got when I was a child. The biggest problem in feeding the poor has changed from not enough food to obesity. Poor people today usually have smart phones, nice clothes and appliances that not every middle class person had when WWII ended. As Mark likes to point out, a lot of the disappearing middle class has disappeared into the very upper middle class.
This does not mean that income inequality hasn’t also increased. It has. And human nature being what it is most people care more about their relative status than their absolute status. And not just poor people.
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Sorry, in my response to you, Greg, I completely ignored your comment about stagnation.
Yes, it was half-hearted. It’s a thesis I do not believe. I was using it as a possible example to my point about metrics.
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Hi Jon
I’m not familiar with Garrison, so I can’t comment on his model.. Could you elaborate briefly on the problems you see with it, as I prepare to learn something about Garrison?
As I expected, my comment got Greg’s attention, and also as expected, he is scoffing at any mention of the ABCT, although apparently he can modulate his scoffiness.,
I think he has at least two problems, which I will address with him directly in a comment.
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My short reply to both of you:
Roger Garrison is a brilliant economist from Auburn University. He attempts to formalize Hayek’s “capital triangle” (what Ron is referring to) and provide a more graphical representation of why the change in interest rates causes a boom-bust cycle. Modern ABCT is based off his work. The idea is good but the theory is wrong. Basically, one of the mechanisms he has is production moving beyond the PPF (say, to point D on the graph above). However, such a move is impossible and he’s never fully explained to my satisfaction how that can happen. So, one of the key mechanisms for the boom-bust cycle is based off an impossibility, and that is problematic.
I recommend this pretty ok overview of Garrison’s model: https://www.slideshare.net/zayets/hayek-vs-keynes-presentation
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Thanks, Jon
I was indeed referring to the Hayekian Triangle, which to me makes perfect sense as an explanation of the role of interest rates in an economy, and it makes it easy to see how manipulating the natural or market interest rate as is done by the Fed would lead to misallocation of resources on a massive scale over time.
The slide show you cited doesn’t display correctly for me on two different browsers. I will look elsewhere.
And you are right, producing at a point outside the PPF isn’t possible, otherwise it wouldn’t be known as a “frontier”. I’ll see what I can find out.
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Hi Greg
As expected, my comment about ABCT drew you like a magnet to this blog, and also just as predictably you found it scoff-worthy, but I must say I’m disappointed in your response. You are better than this,Greg, A basically ad-hom response along with reliance on a previously debunked argument whose only claim is a numerical count of financial crises between two historical periods, one with the Fed and one without. I expect better from you.
I agree with Jon and most Austrians that the ABCT needs some work, but the basic premise that third party manipulation of an important price – the interest rate – obscures information consumers and producers both use to calculate time preferences, and leads directly to the misallocation of resources you readily admit takes place during a boom cycle, which inevitably results in a bust cycle during which resources are reallocated to their most efficient uses.
It’s not clear why you want to minimize this effect on the business cycle, because it would seem to be the most important cause of business cycles. It is artificial monetary and fiscal stimulus that cause the unsustainable boom side of the cycle that must inevitably result in the bust, which is the corrective portion of the cycle.
If you are interested in business cycles before the Fed, you might want to watch this presentation on the subject.
Notice the Mises Wiki entries at that website for several of the 19th century panics you claim occurred during a more “Austrian era” – whatever that means. Many appear to involve the familiar hand of government intervention in markets including inflation of the money supply. Check them out.
As I see it, you are making two errors: First is a belief that some group of really smart people can manage a marketplace involving 300 million people better than they can manage it themselves using a market price system, and then you seem to have cause and effect of business cycles reversed.
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Ron,
I don’t understand your reply. Why do you think my response was “basically ad-hom” and when was the point about comparing the number of financial crises ever “previously debunked”?
The idea that the Fed “obscures” information about interest rates is not defensible. There is a vast amount of information available about what the Fed is doing now, what they expect to do, and how they are likely to react if unexpected events occur in the future. None of this information even suggests that today’s interest rates are likely to remain unchanged. An investor can get within seconds now a level of information on these things that was previously unimaginable. For example, just yesterday I read an article pointing out that the yield curve is nearly inverted and that historically predicts a high risk of recession in the not very distant future.
As Tyler Cowen always points out, Austrian theory depends on investors never learning from these patterns and anticipating how the Fed will react to inflation, no matter how many times these patterns repeat. Austrians have to believe that investors are so dumb they get fooled every time by the Fed. Like Tyler Cowen I have a lot more confidence than Austrians do in the ability of investors to learn from and respond to incentives and patterns regarding interest rates.
Private credit markets are just as capable of sustaining a credit boom as central banks. Some of the biggest financial bubbles in history did not require financing from a central bank. The Dutch Tulip Bubble, the South Sea Bubble, and the Mississippi Bubble all long preceded the era of Keynesian central bank interventions.
I though it was crystal clear what I meant by calling the earlier era one of relatively more Austrian policy responses. It did NOT mean there was ever somewhere government had no effect on the economy. It DID mean there was VASTLY LESS government manipulation of the economy (both fiscally and monetarily) then there was in the later era. You are being uncharacteristically disingenuous on this point.
Since we don’t live in a world of pure Platonic forms you can always hide behind the fact that no one will ever be running policy exactly the way you are advocating. (Just as the few remaining Marxists always do) The point is there is a spectrum of policy responses from less to more interventionist. There is a big difference between these two eras in which was more or less interventionist. Surely you are not denying that.
It’s not like you to duck a tough question. Why then did the era with RELATIVELY much more Austrian policy responses result in so MANY MORE financial crises when the whole point of Austrian policy is explicitly to make growth sustainable?
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Reblogged this on Utopia – you are standing in it!.
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Greg
Perhaps ad-hom was too strong an accusation. I will settle for “unnecessarily snarky” based on the following quote:
“ABCT requires a belief in the power of theory over evidence. And wouldn’t you know it, deep in the cults of ABCT is precisely where you can still find people arguing that economics is a deductive science that need not concern itself with awkward empirical facts.”
Actually ABCT appers to be a pretty good set of deductions based on observation of what actually occurs during both the boom and the bust phases of a cycle.
Yes, I was referring to the Hayekian Triangle explanation (thank you Jon), but couldn’t for the life of me remember the name, so I was unable to cite adequate references. I find it a very compelling basis for an explanation of the ABCT. Here’s a good summary:
https://wiki.mises.org/wiki/Hayekian_triangle
This is the tl;dr heart of the matter: ” Here, interest rates are key. If a society decreases current consumption and saves more, real interest rates are lowered. With lower interest rates, entrepreneurs have more incentive to invest in earlier stages of production for two reasons: (1) consumers are spending less on retail goods, and (2) lower interest rates mean entrepreneurs can borrow more money, cheaper, for investment.”
Notice the reference to “real” or market interest rates, not the interest reates artificially created by Fed monetary policy, which encourage entrepreneurs to invest in higher order stages of production, and for longer terms than is justified by consumers’ actual propensity to save. Consumers who, in fact, are being encouraged by these artificially low interest rates to borrow and spend instead of saving.
Also notice that at the start of a recession the first industries to suffer are those in the highest stages of production, even while lower order stages closer to final consumption continue to flourish because consumers are still spending their little hearts out, and they continue to do so until increased unemployment reduces consumer spending also.
So blaming a recession on “inadequate aggregate demand” is equivalent to missing the whole first half of the movie. Attempts to “prime the pump” and “put dollars in the hands of consumers” by keeping interest rates artificially low is to continue the error that led to the recession in the first place. Recessions are the necessary corrections to previous disastrous policies. As with all central planning, it just doesn’t work. Just let the market work unimpeded.
I could have sworn that you and I discussed this subject of financial busts before and after the Fed at great length in the past. If it wasn’t you, than I apologize for the “previously debunked” comment. I guess we can have that conversation now, if you wish, but I don’t believe a comparison of that nature based on only the number of occurrences is particularly helpful. Obviously there are other factors involved in business cycles other than the Fed, but if you check some of the descriptions at the link I provided, you can see that many of the pre-Fed panics were nonetheless related to inflationary government monetary policies. The government issue of “Greenbacks” in the 1860s to finance the War of Northern Aggression is a good example.
“The idea that the Fed “obscures” information about interest rates is not defensible. There is a vast amount of information available about what the Fed is doing now, what they expect to do …”
Of course. What I meant is that Fed policy obscures the true state of peoples savings rates, so the true market rate of interest is not known.
“As Tyler Cowen always points out, Austrian theory depends on investors never learning from these patterns and anticipating how the Fed will react to inflation, no matter how many times these patterns repeat.”
Umm … The Feds CAUSE inflation. Just follow changes in the money supply to see which direction the inflation pointer is pointing. The fed reacts to inflation by reversing its previous destructive moves. Too bad they can’t account for an economy and markets involving 300 million people.
“Austrians have to believe that investors are so dumb they get fooled every time by the Fed. Like Tyler Cowen I have a lot more confidence than Austrians do in the ability of investors to learn from and respond to incentives and patterns regarding interest rates. ”
It’s not a matter of knowing, it’s a matter of finding reasonable alternatives. Incentives matter. A low interest rate encourages investments in longer term projects. Whether or not anyone is fooled by the fed, they must deal with the interest rate environment they are in at the moment. Knowing that the train is headed for curve that will end with derailment doesn’t allow investors to just sit on the sidelines letting opportunities for profit to fly past on that speeding train. The must play the game even knowing that the party will end sometime and many will be left holding the bag.
Before the Great recession (almost) everybody know the housing market was in a yuge bubble that would pop some time in the future, leaving a large inventory of surplus housing, dropping prices,, and many, many losses. What could a builder do, knowing the music would eventually stop and leave many without chairs? Sitting out the bubble wasn’t an option. Buyers hoped to profit on rising housing prices knowing they could seell to some “greater fool” down the line.
It’s not a matter of not knowing what’s happening and being fooled, its a matter of not wanting to miss the action.
“ (Just as the few remaining Marxists always do).”
Now you compare me to a marxist! Is there no end to your cruel disparagement?
“ Austrian policy responses result in so MANY MORE financial crises when the whole point of Austrian policy is explicitly to make growth sustainable?”
I’m not sure there is any such thing as an “Austrian policy” other than an extreme revulsion for government interference in the activities of otherwise peaceful people. As you pointed out, pure Austrian theory is pure deduction and doesn’t require any empirical facts, so promoting policies would be quite foreign to a true Austrian. Perhaps I should read some Garrison to find out more.
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Ron,
Since snakiness is everywhere and always unnecessary, I won’t attempt to deny that my snark was unnecessary. But we do need to clear up some of the details on what ad hominem means.
An ad hominem is a logical fallacy where the person committing the logical fallacy claims that another person’s claim could not possibly be true BECAUSE of some defect in that other person’s character or judgment. It is a fallacy precisely because it is POSSIBLE for someone with bad character or judgment to assert something that is true. Just as it is possible for someone with good character and judgment to be mistaken.
Ironically, my claim that you originally labeled an ad hominem, was almost the polar opposite of an ad hominem. I was arguing you had made a mistaken argument even though I happen to regard you as having GOOD character and normally good judgment.
It is, however, entirely possible to criticize someone’s character and judgment and even to claim that that should cause us to be suspicious of their claims without committing the logical fallacy. To avoid the fallacy you simply have to NOT claim that the conclusion necessarily follows logically.
An ad hominem is literally “at the person” (rather than the argument). My description of your version of Austrian theory as cultish is aimed at the ideology of the cult’s claims it has discovered a “deductive science.” My understanding is that not all Austrian economists think economics is a “deductive science” but we can have Jon arbitrate that claim.
“Deductive science” is an oxymoron. Science is not limited to deduction. In science, hypotheses are formed through induction and evidence is accumulated through observation and experiment. Only REASONING is deductive in the sense that logical fallacies in reasoning are not tolerated. All knowledge is regarded as provisional and subject to challenge from further evidence.
You say that Austrian theory is a “set of deductions based on observation.” No. Deductions are based on ASSUMPTIONS in a deductive system. Deductivist Austrians insist that their conclusion could not possibly be overturned by real world observations because they view their assumptions and logic as unassailable. It’s a faith based system. That’s why you are so untroubled by going 0 for 17 on the economic unsustainabilty scoreboard. Even though, for the rest of us, the real world consequences of the policy decisions that result from these ideas are the whole point. For deductivist Austrians no future sequence of events could shake their beliefs because they believe that their assumptions and logic are correct.
I’ll address he specifics of the theory and your defense of it in a different comment but for now I’m taking a break.
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Ron,
Austrian economists vastly overestimate the role that interest rates play in fueling the economic cycle. The biggest factor in fueling large unsustainable credit booms is almost always overexcitement about new technology and innovation.
Bill Gates didn’t drop out of Harvard and found Microsoft because he thought interest rates had finally turned favorable. He dropped out because he was convinced he understood the technology better than the competition and that if he didn’t act right away technological advances might reduce the advantage he believed he had at the time. Microsoft didn’t attract a host of competitors operating on borrowed money primarily because of their analysis of interest rates showed that last quarter point move to be decisive. It attracted competitors because it was making huge profits that dwarfed any interest rate considerations.
>—” If a society decreases current consumption and saves more, real interest rates are lowered.”
Well look at that. See just how easy it is to slip into forbidden macro aggregate thinking. Come on Ron. Societies don’t save. Individuals save. Just kidding. This is actually a reasonable claim. I just couldn’t resist using the snark to show you how it feels when the shoe is on the other foot.
>—-“Before the Great recession (almost) everybody know the housing market was in a yuge bubble that would pop some time in the future, leaving a large inventory of surplus housing, dropping prices,, and many, many losses.”
This is a classic case of hindsight bias. Most people did NOT anticipate anything like the kind of crash we had. Most people knew it wouldn’t last forever but thought the market would ultimately plateau and stagnate not crash spectacularly. I actually owned a business selling clothing and work boots into the construction industry at the time. I put my building and my business up for sale in 2005 because I didn’t think the boom would continue, not because I foresaw a crash. I got out in early 2008 just like the guy in the cartoon who steps away from where the piano falls more through luck than design.
That housing bubble was fueled by new financial technologies like CDO’s and Credit Default Swaps that allowed many people to actually believe in good faith that they had found a way to diversify away risk. It was those technologies that drove the boom. The financial gains made during the good years absolutely dwarfed any interest rate considerations and the people who had borrowed the most made the most.
Let’s look at the recession before that one. That was the dot com bubble. Again fueled by belief in new technologies which did produce for years gains that dwarfed any interest rate considerations.
Go back as far as you want and you will find the same pattern. One reason there were so many recessions during the period between the Civil War and Great Depression is that the Industrial Revolution produced an unprecedented number of revolutionary new technologies that excited and over excited investors. Railroad bubbles were everywhere.
Go back even farther to the biggest bubbles of all time. The Mississippi Bubble And the South Sea Bubble were started by enthusiasm over new technologies in sailing and military advantage. The Dutch Tulip Bubble was fueled by the private futures market not government sponsored fractional reserve banking.
You say that Austrians don’t promote policies but a decision for government not to take an action is every bit as much a policy as a decision to take an action and you are incessantly promoting the former.
The role of borrowing in creating unsustainable credit booms is an important one but is much better described by Hyman Minsky than the Austrians. Stability is destabilizing because it rewards risky finance. You don’t need government to make this happen. The worst excesses in the CDO markets and Credit Default Swap markets during the housing boom were all in the private sector. The next time I see an Austrian who even wants to look at these private sector developments will be the first time.
Austrians always come in after the fact and detect an error in Fed policy on interest rates. The diagnosis is not the least bit dependent on the specifics of the case. It has all the suspense of wondering if your chiropractor will detect a subluxation.
Ask an Austrian what their theory predicts about the future based on current interest rates and hilarity ensues. The thing they were most sure of was that a disastrous debasement would result from the Fed’s giant expansion of its balance sheet after the Great Recession. Oops. That was actually followed by the lowest inflation of our lifetimes.
Oh well. It’s lucky that you don’t need to worry about such errors in your “deductive science.”
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Greg
“ But we do need to clear up some of the details on what ad hominem means.”
Thanks for the lesson, but I’m pretty sure I understand the concept of ad hominem fallacy, and that’s why I withdrew my previous accusation which I had thrown out too hastily.
“ Most people did NOT anticipate anything like the kind of crash we had.”
Yes, and most of those people who didn’t anticipate a crash worked for the Federal Reserve. After nearly 100 years of practice to get it right, the Fed STILL can’t maintain stability in the economy – including two of the worst recessions/depressions ever. You make the case yourself, by blaming novel private financial arrangements outside the control of the Fed for the recent Great recession. To paraphrase one of your favorite anarchists, Lysander Spooner:
““But whether the Federal Reserve really be one thing, or another, this much is certain – that it has either authorized such destructive business cycles as we have had, or has been powerless to prevent them. In either case it is unfit to exist.”
I know we have had this conversation about Austrian economics before without any positive outcomes so I will take a pass on the full ride this time. I’m currently involved in a project with my grandson and have vacation planning coming up that is getting me out of this comfortable chair way more than I would prefer. Perhaps some other day when I have more time to spend on it.
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Ron,
OK have a great vacation. I would choose time with grandchildren over an internet argument anytime. That shows good judgment. I just hope you won’t later remember this time where where you are taking the pass as the occasion where my point about the vastly reduced number of post war recessions was “previously debunked.” Not to worry. if memory fails you can trust me to remind you.
As no less a libertarian giant than Milton Friedman has shown, the Great Depression was caused by Fed INaction while the money supply shrank and by sticking with the gold standard too long. Austrians WANT the Fed to leave the money supply alone and stick to the gold standard. You can blame the Fed for that one if you like but you should remember that you are blaming them for a POLICY that is relatively much closer to the one YOU want than the one I am defending.
As for there being a second one of the “worst recession/depressions ever” caused by the Fed, I can’t even tell what you are referring to. If it’s the Great Recession, then there are 17 that were both deeper and longer during the period of much less government management of the money supply. If it’s the 1920/21 Depression, then we are all the way back in the period where the Fed didn’t do much even though it had the legal authority to in principle. And in any event that Depression was much shorter than many of those in the earlier era.
Note that I do NOT claim that there is, or could be, any guarantee that the Fed can maintain stability in the economy. I merely claim they can, and usually do, make it considerably better than it would have been without their efforts. As evidence, I cite the fact that in the period of active Fed management of the money supply after WWII there were NO recessions or depressions as severe as the SEVENTEEN worst in the period of radically less market intervention between the beginning of the Civil War and the beginning of the Great Depression.
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