Archive for business cycles

In Mises’s Birthday: Rothbard on Mises’s Contribution to Understanding Business Cycles

mises2Mises Daily Monday: Rothbard explains how Mises laid the foundation for Austrian Business Cycle Theory:

In The Theory of Money and Credit, Mises provided the basics for the long-sought explanation for that mysterious and troubling economic phenomenon — the business cycle.


Why the Mainstream Fails to Understand Recessions

6797Mises Daily Wednesday by Hal Snarr.

Mainstream economists often still maintain that nobody predicted the 2008 financial crisis and recession. Many Austrians saw it coming, of course, and thanks to the work of Roger Garrison and other Austrians, we also better understand the details of how booms and busts work.


This Boom is a Problem

220px-Dangclass1.svgWriting for the Globe and Mail, Tom Bradley is worried about the markets:

It feels like investors have become complacent about – well – everything.

The strongest consensus I’ve seen in recent years relates to low interest rates. The rationale is, rates won’t go up because we can’t afford it. A question from a client last week embodies this view. He asked, “Can interest rates actually increase?”

Related to rates is an increasing comfort with debt. Carrying costs are low and families are okay with heavily leveraged balance sheets. Instead of, “How fast can I get my house paid off?,” the question is, “Should I get an investment loan to go with my mortgage, home equity loan, credit line, car lease and credit cards?”

One of the striking features of Austrian business cycles is the emphasis on the things one doesn’t see that are going wrong during the boom. In other words, while by all appearances the boom seems like a great time, in reality it is quietly sowing the seeds of its own demise.

It is exactly this feature – the emphasis on the unsustainability of the boom – that gives Austrian economists an advantage over other economists when assessing business cycles. No other look at the business cycle has any broad measures against which it can judge whether the boom “should” be happening in the first place. Instead the bust always gets the blame as the problem, which is only really true if it wasn’t caused by the boom that precedes it.

Bradley is correct about three facets of today’s markets. First, interest rates are at all time lows. While in the past this used to mean in real (inflation-adjusted terms), with central banks pegging their main financing rates at or close to zero, this is true in nominal terms as well. Second, not only are debt levels high but borrowers don’t have much incentive to pay them off any time soon. Finally, and most importantly, no one expects this situation to reverse any time soon. Why would it: don’t you know we’d all be doomed if interest rates rose?

The longer these imbalances continue, the more difficult the problem will be to unwind. There’s no such thing as a free lunch, and when interest rates rise again (probably in a response to rising risk due to bad investments made in the past) we’ll see whether this boom was sustainable or not. Of course, Austrian economists are able to answer that question already.

(Originally posted at Mises Canada.)

The High Price of Delaying the Default

Politician kicking the can down the roadThorsten Polleit writes in today’s Mises Daily:

Running the electronic printing press will be perceived as the policy of the least evil — a reaction that could be observed many times throughout the troubled history of unbacked paper money. Since the end of 2008, many central banks have successfully kept their commercial banks afloat by providing them with new credit at virtually zero interest rates.

This policy is actually meant to make banks churn out even more credit and fiat money. More credit and money, provided at record low interest rates, is seen as a remedy of the problems caused by an expansion of credit and money, provided at low interest rates, in the first place. This is hardly a confidence-inspiring route to take.

It was Ludwig von Mises who understood that a fiat money boom will, and actually must, ultimately end in a collapse of the economic system. The only open question would be whether such an outcome will be preceded by a debasement of the currency or not:

Read the full article.

Wall Street Cheerleader Bummed by Austrian Lack of Enthusiasm

340px-Early_women_cheerleaders_at_UW_Madison_(2246608893)Today at The Street, Dana Blankenhorn writes that you shouldn’t let the Austrians at the Mises Institute harsh your buzz.

Blankenhorn implores his readers to “Ignore The Doomsday Chorus” and observes:

What most of today’s Doomsday Chorus has in common is a devotion to libertarianism and to Austrian Economics, which holds that there are absolute rules about economic behavior that can be deduced logically, and that government is powerless against these rules.

Robert Murphy, a scholar associated with the Mises Institute, whose slogan is “Advancing Austrian economics, liberty and peace,” explained the difference between Austrians and monetarists such as outgoing Federal Reserve Board chairman Ben Bernanke in a 2011 essay for the Institute.

Milton Friedman, the “Chicago School” economist and monetarist, blamed the Great Depression on tight money, Murphy wrote, and Bernanke’s policies aimed to push up the money supply to compensate. “These views are anathema to modern Austrians,”  who “think the central bank should be abolished.”

What’s worse, the Austrians are now even somewhat influential, which is an especially big bummer:

Thus, if you liked Ron Paul or think the Mises Institute makes economic sense, the current economy looks like a bubble that is bound to pop. With a whole school of economics riding on the outcome, seldom has the Doomsday Chorus featured such a distinguished company as it does today.

Read More→

The Real Greenspan

225px-Greenspan,_Alan_(Whitehouse)In a recent not-an-interview on Harvard Business Review‘s HBR Blog Network, Alan Greenspan reveals his true self as a central banker and student of ”economics.” One might think that the former Collective member would understand and appreciate the workings of the market, but if there ever truly was a Greenspan like that he’s long gone.

The Greenspan that emerges in this text is a man who romanticizes about economic planning, who believes in his ability to rationally plan and thereby ”save” the market (from itself). It is possible that the author’s anti-market bias shines through in the text’s “heavily edited excerpts,” but the Greenspan that is portrayed is the typical megalomaniacal central banker. And he obviously approaches the study of economics from a purely statistical, quantitative, and inductive point of view.

To illustrate, at the beginning of the “interview” Greenspan expresses his real disappointment about not being able to get down to [statistical] business:

I had an idea of constructing a certain statistical procedure. I called in a bunch of the senior analysts and I say this is what I have in mind. They all said, “Oh, it’s a terrific idea. Let’s do it.”

I said, “I’m going to do this one.” Silence. One guy says, “You’re CEO. You’re a chairman. You do CEO/chairman stuff. We do the research here.” I mean, I was really put down.

Poor Greenspan had the power to rule them (us) all, but was not expected to do “real” economics: fiddle with the statistical models used in controlling the economy.

The “interview” is unsurprisingly littered with talk about looking at the ”data,” as well as phenomena that Greenspan seems to think appear spontaneously. Bubbles, it is suggested in the text, have no obvious cause, but Greenspan, in all his divine experience, has come up with a novel (?) idea: bubbles seem to be preceded by “good central bank performance” (!) and hence by “a prolonged period of economic stability, stable prices, and therefore low risk spreads, credit-risk spreads.” I guess that’s one way of putting it, and staring at the data won’t ever get us closer to the truth than “there seems to be a correlation here.” (Even Paul Krugman knows better.)

This “interesting theory” (according to the author of the article) is obviously not interesting enough to spend time talking about, because the “interview” rushes on to discuss the real problem for the central bank. In Greenspan’s words, “the question is, do you quash the bubbles?” Right, when bubbles mysteriously appear “despite” the central bank’s “performance,” what do you do?

Something tells me there is no good answer to this highly irrelevant question.

100 Years Ago: Why Bankers Created the Fed

6616Christopher Westley writes in today’s Mises Daily, on the Fed’s 100th birthday:

The boom and bust cycle, explained by the Austrian School in such detail, became worse and worse in the period leading up to 1913. And with the rise of Progressive Era spending on war and welfare, and with the pressure on banks to inflate to finance this activity, the boom and bust cycles worsened even more. If there was one saving grace about this period it would be that banks were forced to internalize their losses. When banks faced runs on their currencies, private financiers would bail them out. But this arrangement didn’t last, so when the losses grew, those financiers would secretly organize to reintroduce central banking to America, thus engineering an urgent need for a new “lender of last resort.” The result was the Federal Reserve.

This was the implicit socialization of the banking industry in the United States. People called the Federal Reserve Act the Currency Bill, because it was to create a bureaucracy that would assume the currency-creating duties of member banks.

It was like the Patriot Act, in that both were centralizing bills that were written years in advance by people who were waiting for the appropriate political environment in which to introduce them. It was like our current health care bills, in which cartelized firms in private industry wrote chunks of the legislation behind closed doors long before they were introduced in Congress.

After the Taper: The Fed’s Non-Plan Is Unchanged

6621Frank Hollenbeck writes in today’s Mises Daily:

Since 2008, the central bank has reduced interest rates to almost zero with little to show for it. You can bring a horse to water in a trough, pond, or lake, but you cannot make him drink. Most of the added liquidity has found its way into excess reserves. Banks are not lending because they have few creditworthy customers who want to borrow. The household sector is still deleveraging and has less appetite for more debt, and the business sector is careful about making future investments in a financial and economic environment on unstable footing. Businesses are keenly aware of the malinvestments never cleaned up after the last bubble and of the price distortions of current monetary policy. Why would businesses stick their necks out if they suspect a painful adjustment is around the corner?

Since the first channel has failed, only the second channel remains. Economists are generally in agreement, however, that there is no long-run trade-off between inflation and unemployment. The Keynesians and monetarists believe that there may be a short-run trade-off. If people have adaptive expectations, (based on the recent past) then monetary policy that creates inflation will reduce unemployment by lowering a worker’s real wages. Of course, once a worker realizes he has been fooled, he will demand an increase in nominal wages to bring his real wages back up to previous levels. The gain in employment is only temporary. If, instead, people base their expectations rationally and are not fooled, the neo-classical position, there is no short- or long-run trade-offs between inflation and unemployment.

Renewed Interest in the Mises-Hayek ABCT

One of the few positive aspects of the back to back boom-busts episodes experienced by the U.S. and world economies is a renewed interest in the Mises-Hayek-Rothbard-Garrison-Salerno or Austrian business cycle theory (ABCT) coming first from the financial press and more recently from ‘mainstream’ macro economists. I recently showed how the renewed interest proved Krugman wrong about Mises and Hayek. For the more wonkish, Nicolas Cachanosky (my replacement at Metro State) and Alex Salter have just released what Pete Boettke calls a “new working paper that EVERYONE must read”, “The View from Vienna: An Analysis of the Renewed Interest in the Mises-Hayek Theory of the Business Cycle”.
The abstract:

This paper analyses the renewed scholarly interest in the Mises-Hayek, or “Austrian,” theory of the business cycle since the 2008 financial crisis. Understandably, the economics profession has broadened its search for the crises’s explanation beyond the standard DSGE framework. Austrian business cycle theory, with its emphasis on the importance of the monetary system for resource allocation and the linkage of consumer demand with producer supply through the coordination of the economy’s structure of production, offers a fruitful realm for productive intellectual arbitrage in business cycle research. After reviewing the post-crisis literature that engages Austrian business cycle theory, we discuss what is being said that is correct, what is being said that is incorrect, and what is not being said that ought to be said. This last category is most important largely due to the fact that the post-crisis literature engaging Austrian business cycle theory has not addressed advances in the theory made since the days of Mises and Hayek. We also present modern work being done on Austrian business cycle theory and highlight three key areas of contemporary economics where Austrian business cycle theory has the potential to do significant work.

The conclusion:

We also suggest how the modern treatment of the ABCT can contribute to different contemporary economic puzzles, like the Phillips Curve with a positive slope [Dynamic Monetary Theory and the Phillips Curve with a Positive Slope, by Adrián O. Ravier] output comovement in small open economies with different exchange rate regimes and the problem of GDP as a trend-reverting or a unit root series. Certainly further research in all these areas is needed. We think that the treatment and layout we present in this paper shows that there are gains of trade to be gained between “Austrians” and “non-Austrians.” This intellectual arbitrage has the potential to expand significantly the explanatory power of modern economics, and should be embraced by all economists, however they self-identify.

My small quibbles with this excellent and timely paper; wish they had incorporated more from Joe Salerno’s recent and excellent extension of ABCT, A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis, into some of their discussion of recent important contributions and Cochran’s “Capital in Disequilibrium: Understanding the “Great Recession” and the Potential for Recovery” in their discussion of the supposed weakness relative to the recession/recovery phase of the cycle.