For those who want to investigate ABCT in detail, there is plenty of material to ponder in the recent debates on Coordination Problem. Of course, this is no substitute for a detailed study of the literature, but, however, without knowledge of this literature most of the debate is fairly incomprehensible.
Many aggregate-demand analysts tend to think that a recession can be made less severe, or altogether avoided, by increasing the money supply in order to offset, or more than offset, a fall in velocity.
The objection that has been raised by many, me included, in the comments of the linked post is that malinvested firms are the most likely to ask for an extension of credit, so that prima facie most of the easing of credit (money) constraints will be used to postpone the liquidation of malinvestment and the consequent recovery.
The criticism has not been answered. In the comments, I refer to a work by Peek & Rosengren on the behavior of Japanese banks during the lost decade. I also have to cite a casual remark by Hayek in "The formation of capital" about the dangers of relational banking throwing good money after bad.
Besides, I cited the last three chapter of Hayek's "The pure theory of capital" because his criticism of Keynes's liquidity preference analysis is perfectly suitable to criticize also attempts to stimulate aggregate demand: a liquidity demand increase arising out of an unsustainable structure of production is not really a rise in liquidity preference, but banks (as in "Monetary theory and the trade cycle") have no means to distinguish between the two.
It is of course conceivable that an exogenous rise in money demand puts pressure on production because of short-run rigidities. It is impermissible to think that easing monetary and credit conditions when most of this increase in money demand is endogenous to the structure of production is a solution to the problem of malinvestment.
giovedì 22 aprile 2010
sabato 10 aprile 2010
ABCT debate
Following Krugman's and Cowen's criticism of Austrian Business Cycle Theory several days ago, Boettke has written a post on Coordination Problem and the debate in the comments is strongly suggested for the intermediate/advanced students of ABCT.
I cut and paste my comments because I'm quite proud of them.
The first was on the strange argument by which every change in the structure of production must yield unemployment because workers are laid off, so that the boom must increase unemployment. The argument is based on the confusion between structural changes which increases the demand for labor somewhere and structural changes that reduces the demand for labor somewhere else.
If demand increases in long-term capital goods, unemployment is reduced AND the structure of production is changed; if demand decreases in long-term capital goods, unemployment is increased AND the structure of production is changed. There is no reason to expect that ANY change in the structure of production need increase unemployment: there are structural changes involving a fall in job vacancies (increased employment) and structural changes involving a fall in job positions (increased unemployment).
Then I go astray and comment on a totally unrelated topic which has been raised by someone, I hope (otherwise I'm delusional). FRED is the Federal Reserve Economic Data database. Summary: there is no compelling reason at first sight to believe that long rates are not affected by monetary policy, at least looking at the rates. The regressions I ran are quite laughable but to me appears to prove the point. A more serious analysis should consider a vector autoregression specification, several control variables, and real interest rates. I don't have any experience in applied economics, also because it is so overvalued that I'm bored by it.
I don't understand the idea of the long-run rates untouched by monetary policy. Interest rates move in parallel, just look at FRED to be sure. Correlation between fed funds and 3-year interest rates is very strong (R-squared 0.87 with a RATE3Y=a+b*FEDFUND equation). This means that to know the present monetary policy and to know the present structure of commercial paper, t-bills and constant maturity treasuries rates is almost the same thing, from 1m to 5y. One can phone Bernanke and know the whole structure of the interest rates listed above by just asking for the Fed rates. So, either Bernanke looks at the interest rates and sets the target rate, or it affects interest rates at all maturities with his only policy instrument. The latter appears to be the correct explanation to me: a 1% cut in Fed funds is a 0.6% cut in 5y rates, i.e., a 3.3% compounded gift to 5y debtors. But maybe I'm missing some VAR specification and some data modeling...
My third comment was about many themes:
As a Garrisonmania suggestion, considering that the comovement issue (does consumption fall or rise with investments?) has been discussed by many, there is a 1993 (I guess) paper, available on his site, about overconsumption and forced savings in the theories of Mises and Hayek. Although that material is also in Time and money, that article for me is the starting point to assess most of Krugman's and Cowen's (and Woolsey's, Tullock's...) criticisms of ABCT. The standard version of ABCT with reduced consumption during the boom originated with Hayek and is so at odds with reality that although I believe ABCT is right I would never say that. :-) For what concerns praxeology, I quote Boettke: praxeology is not absurd, although less powerful than most think. However, although hyperrationalist interpretations of Mises are for bloggers, they are not the layman's fault: Rothbard and Hayek sometimes made the same mistake. The problem is that Mises is read in terms of Theory and the other 50% of his epistemology, History, is downplayed. Theory is a jackknife, not a miracle machine.
Then I decided it was time for overshooting and wrote a little treatise on ABCT. This comment is long, maybe too much, and probably difficult to follow.
First point: I never said that the boom/bust is a nominal phenomenon:
My point is that *real* GDP rises more than sustainably feasible, the fact that NGDP rises is true, too, but not central. The economy is overheating in real terms during the boom, producing beyond capacity: it's Y/P > PPF.
The second point is that overproduction beyond the PPF has nothing keynesian. A theory of a real resource crunch follows (the exogenous credit crunch due to inflationary fears was too common sense for me).
Real overproduction is not keynesian, it is misesian (in Hayek there is nothing like that): malinvestment and overconsumption are a movement beyond the sustainable production possibility frontier, not a free lunch of an economy working below it's potential due to market failures. Only movements within the PPF are keynesian (or MET, or credit channel).
I would describe the boom in three chronological steps, in which the first one lasts a money circulation period (one month?) and is separated for expository purposes only:
phase 1: money injected as credit causes an investment boom.
phase 2: money originally injected as credit circulates as wages and causes a consumption boom. (underlying hypothesis: C and I go beyond the sustainable PPF, otherwise phase 2 would cause a halt to investments).
phase 3: binding production constraints halt the simultaneous booms, prices may start rising, consumption and investment will no longer be able to comove, the boom ends independently on monetary policy (the delay between phase 3 and 2 is not due to monetary circulation, is due to the time structure of production: overproduction is possible, but not forever).
The third point regarded the comovement of investment and consumption.
1. It is true that price rigidities (MET) can push the economy below its PPF.
2. Not only price rigidities can do this: also credit deflation (as in Strigl, "Capital and consumption") and financial accelerators of various kinds. MET is a special case of a more general class of accelerators which make the recession harder than neoclassically ("movements along the PPF") necessary: all kinds of financial frictions can do the same job as price rigidities.
3. Even if the bust had no decelerators (the original Austrian "below PPF" accelerators are credit destructure and panic coordination problems), real expenditures in consumption should *fall* and not rise during the recession, because the recession is the discovery of the squandering of capital, i.e., it is an inward movement of the PPF. In reality, part of the recession is not a movement of the PPF, of course. There are frictions, and rigidities are one of them.
Another point was about the relation of credit and monetary disequilibrium. I haven't finished the study of this theory (is there a study which has an end?), however. I end up criticizing Hayek.
I'm not going to say that ABCT explains the severity of all the recessions, it is not true (as recognized by Mises 1931, C. Phillips 1937 and Rothbard 1963 for the Great Depression, when they pointed out the role wage rigidities). But the recession happens when productive unsustainability is revealed, it is a concept that can do without nominal frictions (which, however, exist).
As there is no exposition of ABCT which satisfies me on this point, the best being Garrison's - as usual - which is too aggregate, I make an example.
Let's assume that I've undermaintained old fixed capital for five years. I've moved workers toward the production of new fixed capital (which will require a lot of saving which will not be available on time and which adds to the consumption stream during the overconsumption phase), and toward the production of consumption goods. I can do this because fixed capital is durable, and as long as old and new fixed capital does not physically deteriorate, the boom can go on. When however the surge in the demand for saving arrives but demand for consumption remains strong, the recession begins. During the recession I have to reduce consumption, invest in the old and new fixed capital to save part of it, and scrap the unusable (for lack of complementary capital goods, i.e., savings) submarginal part of it.
This would be a problem also without frictions. Frictions only add severity and length to the readjustment. The countercyclicality of consumption which Krugman and Cowen criticize only exists in Hayek's writings, but not in Mises's or Strigl's or Garrison's. Hayek's theory of forces saving is the standard account of ABCT, but it is theoretically indefensible. Unfortunately, more sophisticated versions to my knowledge are way too complex. What really happens to the economy during overproduction and how real resources come to bind at the onset of the depression is at least to me still a mystery.
An interesting point I never analyzed in detail was why the crisis is sudden. I don't answer the problem because I need more careful thought on it.
Hayek said that it is impossible to consume now what will be available for consumption tomorrow, although it is always possible to save and invest now what is not consumed today: it's the time of production asymmetry. Frictions (among which price rigidities, I repeat, are only a part of the problem) add to the problem. I would consider, however, speed as a positive thing: it is better to have a 3 months crisis then a 5 years one, even for similar cumulative losses. The ideal would be a one week crisis: 100% unemployment for a week and then business as usual. This is impossible, however, because the capital structure need be fixed before reverting toward the sustainable path. Fixed capital is to be reshuffled, consumption need to change, workers need to be retrained and reallocated. I would allow several months for this, and for the panic and the ensuing coordination problems, even in the best case. This is a point I never considered, thanks.
There can be, however, a slow recession, which implies no readjustment of capital: Greenspan called it a soft landing. We saw them in 1921, in 192 and 1927, and in 1990 and 2000. Problems weren't solved, just postponed, but the bill turned out to be expensive. Can there be a slow recession, i.e., a slow building up of demand for capital because of capital undermaintenance during the boom which causes a slow reduction in employment, capital utilization, output, monetary multipliers and consumption which does not impede recovery? Can time be bought for readjustment?
I believe that the secondary deflation is at least in part unavoidable. It adds to the pain, but there are no painkillers available. Friedman and Schwartz said that the expansion in the '20s made the banking system more vulnerable to shocks. There is no boom without an overextension of monetary multipliers, financial leverage, risk... and there is no recession without a painful return to normalcy. If banks need to deleverage, also some good investments will be starved, if banks are forced not to deleverage by nominal expansion, the inherent fragility of their position at the onset of the boom remains (and moral hazard adds to the problem). It is a pity that the financial structure has never played a key role in ABCT... and it is largely compatible.
Back to Krugman's argument that the shift from capital-goods to consumer-goods industries should involve no unemployment because it is a shift in relative and not in absolute demand... with applications to Japan.
The argument assumes, however, that production with capital goods (roundabout) and production with hand-to-mouth technologies are equally productive. The lack of saving stops the production process. There is no boom in consumption because there is a tug-of-war between consumption and demand for credit. No one can produce without capital, and if consumption weren't curtailed, there would be no funding available for the restructuring of production.
I will make an easier example. Krugman (Brookings, 1998) said that devaluation may have helped the Japanese economy by fostering net exports. By fostering carry trade, however, devaluation would just siphon domestic savings out of the country. With which funds were Japanese going to restructure their economy, if investing in T-bills was better than investing in Mitsubishi bonds?
Finally, submarginal capital! What is it? What does constitute it?
I agree with Barkley Rosser in that overproduction is intuitively and theoretically a more complex object than the basic (and indefensible) Hayekian story of forced saving and reduced consumption.
As far as I know, what happens to the economy when there is overproduction has never been analyzed in details. Garrison talks of triangles pulled at both ends, but it's a metaphor, not a theory. He also talks of money illusion by part of workers, which can cause overproduction. Hayek and Machlup occasionally talk about undermaintenance of capital, increased exploitation of capital goods, shifts from long-term to short-term production at the top of the boom (Ricardo effect). However, to my knowledge this is a work in progress, not a full-blown theory.
However, don’t lose time with my comments. O’Driscoll, Woolsey, Koppl and many others have given life to a wonderful thread.
I cut and paste my comments because I'm quite proud of them.
The first was on the strange argument by which every change in the structure of production must yield unemployment because workers are laid off, so that the boom must increase unemployment. The argument is based on the confusion between structural changes which increases the demand for labor somewhere and structural changes that reduces the demand for labor somewhere else.
If demand increases in long-term capital goods, unemployment is reduced AND the structure of production is changed; if demand decreases in long-term capital goods, unemployment is increased AND the structure of production is changed. There is no reason to expect that ANY change in the structure of production need increase unemployment: there are structural changes involving a fall in job vacancies (increased employment) and structural changes involving a fall in job positions (increased unemployment).
Then I go astray and comment on a totally unrelated topic which has been raised by someone, I hope (otherwise I'm delusional). FRED is the Federal Reserve Economic Data database. Summary: there is no compelling reason at first sight to believe that long rates are not affected by monetary policy, at least looking at the rates. The regressions I ran are quite laughable but to me appears to prove the point. A more serious analysis should consider a vector autoregression specification, several control variables, and real interest rates. I don't have any experience in applied economics, also because it is so overvalued that I'm bored by it.
I don't understand the idea of the long-run rates untouched by monetary policy. Interest rates move in parallel, just look at FRED to be sure. Correlation between fed funds and 3-year interest rates is very strong (R-squared 0.87 with a RATE3Y=a+b*FEDFUND equation). This means that to know the present monetary policy and to know the present structure of commercial paper, t-bills and constant maturity treasuries rates is almost the same thing, from 1m to 5y. One can phone Bernanke and know the whole structure of the interest rates listed above by just asking for the Fed rates. So, either Bernanke looks at the interest rates and sets the target rate, or it affects interest rates at all maturities with his only policy instrument. The latter appears to be the correct explanation to me: a 1% cut in Fed funds is a 0.6% cut in 5y rates, i.e., a 3.3% compounded gift to 5y debtors. But maybe I'm missing some VAR specification and some data modeling...
My third comment was about many themes:
As a Garrisonmania suggestion, considering that the comovement issue (does consumption fall or rise with investments?) has been discussed by many, there is a 1993 (I guess) paper, available on his site, about overconsumption and forced savings in the theories of Mises and Hayek. Although that material is also in Time and money, that article for me is the starting point to assess most of Krugman's and Cowen's (and Woolsey's, Tullock's...) criticisms of ABCT. The standard version of ABCT with reduced consumption during the boom originated with Hayek and is so at odds with reality that although I believe ABCT is right I would never say that. :-) For what concerns praxeology, I quote Boettke: praxeology is not absurd, although less powerful than most think. However, although hyperrationalist interpretations of Mises are for bloggers, they are not the layman's fault: Rothbard and Hayek sometimes made the same mistake. The problem is that Mises is read in terms of Theory and the other 50% of his epistemology, History, is downplayed. Theory is a jackknife, not a miracle machine.
Then I decided it was time for overshooting and wrote a little treatise on ABCT. This comment is long, maybe too much, and probably difficult to follow.
First point: I never said that the boom/bust is a nominal phenomenon:
My point is that *real* GDP rises more than sustainably feasible, the fact that NGDP rises is true, too, but not central. The economy is overheating in real terms during the boom, producing beyond capacity: it's Y/P > PPF.
The second point is that overproduction beyond the PPF has nothing keynesian. A theory of a real resource crunch follows (the exogenous credit crunch due to inflationary fears was too common sense for me).
Real overproduction is not keynesian, it is misesian (in Hayek there is nothing like that): malinvestment and overconsumption are a movement beyond the sustainable production possibility frontier, not a free lunch of an economy working below it's potential due to market failures. Only movements within the PPF are keynesian (or MET, or credit channel).
I would describe the boom in three chronological steps, in which the first one lasts a money circulation period (one month?) and is separated for expository purposes only:
phase 1: money injected as credit causes an investment boom.
phase 2: money originally injected as credit circulates as wages and causes a consumption boom. (underlying hypothesis: C and I go beyond the sustainable PPF, otherwise phase 2 would cause a halt to investments).
phase 3: binding production constraints halt the simultaneous booms, prices may start rising, consumption and investment will no longer be able to comove, the boom ends independently on monetary policy (the delay between phase 3 and 2 is not due to monetary circulation, is due to the time structure of production: overproduction is possible, but not forever).
The third point regarded the comovement of investment and consumption.
1. It is true that price rigidities (MET) can push the economy below its PPF.
2. Not only price rigidities can do this: also credit deflation (as in Strigl, "Capital and consumption") and financial accelerators of various kinds. MET is a special case of a more general class of accelerators which make the recession harder than neoclassically ("movements along the PPF") necessary: all kinds of financial frictions can do the same job as price rigidities.
3. Even if the bust had no decelerators (the original Austrian "below PPF" accelerators are credit destructure and panic coordination problems), real expenditures in consumption should *fall* and not rise during the recession, because the recession is the discovery of the squandering of capital, i.e., it is an inward movement of the PPF. In reality, part of the recession is not a movement of the PPF, of course. There are frictions, and rigidities are one of them.
Another point was about the relation of credit and monetary disequilibrium. I haven't finished the study of this theory (is there a study which has an end?), however. I end up criticizing Hayek.
I'm not going to say that ABCT explains the severity of all the recessions, it is not true (as recognized by Mises 1931, C. Phillips 1937 and Rothbard 1963 for the Great Depression, when they pointed out the role wage rigidities). But the recession happens when productive unsustainability is revealed, it is a concept that can do without nominal frictions (which, however, exist).
As there is no exposition of ABCT which satisfies me on this point, the best being Garrison's - as usual - which is too aggregate, I make an example.
Let's assume that I've undermaintained old fixed capital for five years. I've moved workers toward the production of new fixed capital (which will require a lot of saving which will not be available on time and which adds to the consumption stream during the overconsumption phase), and toward the production of consumption goods. I can do this because fixed capital is durable, and as long as old and new fixed capital does not physically deteriorate, the boom can go on. When however the surge in the demand for saving arrives but demand for consumption remains strong, the recession begins. During the recession I have to reduce consumption, invest in the old and new fixed capital to save part of it, and scrap the unusable (for lack of complementary capital goods, i.e., savings) submarginal part of it.
This would be a problem also without frictions. Frictions only add severity and length to the readjustment. The countercyclicality of consumption which Krugman and Cowen criticize only exists in Hayek's writings, but not in Mises's or Strigl's or Garrison's. Hayek's theory of forces saving is the standard account of ABCT, but it is theoretically indefensible. Unfortunately, more sophisticated versions to my knowledge are way too complex. What really happens to the economy during overproduction and how real resources come to bind at the onset of the depression is at least to me still a mystery.
An interesting point I never analyzed in detail was why the crisis is sudden. I don't answer the problem because I need more careful thought on it.
Hayek said that it is impossible to consume now what will be available for consumption tomorrow, although it is always possible to save and invest now what is not consumed today: it's the time of production asymmetry. Frictions (among which price rigidities, I repeat, are only a part of the problem) add to the problem. I would consider, however, speed as a positive thing: it is better to have a 3 months crisis then a 5 years one, even for similar cumulative losses. The ideal would be a one week crisis: 100% unemployment for a week and then business as usual. This is impossible, however, because the capital structure need be fixed before reverting toward the sustainable path. Fixed capital is to be reshuffled, consumption need to change, workers need to be retrained and reallocated. I would allow several months for this, and for the panic and the ensuing coordination problems, even in the best case. This is a point I never considered, thanks.
There can be, however, a slow recession, which implies no readjustment of capital: Greenspan called it a soft landing. We saw them in 1921, in 192 and 1927, and in 1990 and 2000. Problems weren't solved, just postponed, but the bill turned out to be expensive. Can there be a slow recession, i.e., a slow building up of demand for capital because of capital undermaintenance during the boom which causes a slow reduction in employment, capital utilization, output, monetary multipliers and consumption which does not impede recovery? Can time be bought for readjustment?
I believe that the secondary deflation is at least in part unavoidable. It adds to the pain, but there are no painkillers available. Friedman and Schwartz said that the expansion in the '20s made the banking system more vulnerable to shocks. There is no boom without an overextension of monetary multipliers, financial leverage, risk... and there is no recession without a painful return to normalcy. If banks need to deleverage, also some good investments will be starved, if banks are forced not to deleverage by nominal expansion, the inherent fragility of their position at the onset of the boom remains (and moral hazard adds to the problem). It is a pity that the financial structure has never played a key role in ABCT... and it is largely compatible.
Back to Krugman's argument that the shift from capital-goods to consumer-goods industries should involve no unemployment because it is a shift in relative and not in absolute demand... with applications to Japan.
The argument assumes, however, that production with capital goods (roundabout) and production with hand-to-mouth technologies are equally productive. The lack of saving stops the production process. There is no boom in consumption because there is a tug-of-war between consumption and demand for credit. No one can produce without capital, and if consumption weren't curtailed, there would be no funding available for the restructuring of production.
I will make an easier example. Krugman (Brookings, 1998) said that devaluation may have helped the Japanese economy by fostering net exports. By fostering carry trade, however, devaluation would just siphon domestic savings out of the country. With which funds were Japanese going to restructure their economy, if investing in T-bills was better than investing in Mitsubishi bonds?
Finally, submarginal capital! What is it? What does constitute it?
I agree with Barkley Rosser in that overproduction is intuitively and theoretically a more complex object than the basic (and indefensible) Hayekian story of forced saving and reduced consumption.
As far as I know, what happens to the economy when there is overproduction has never been analyzed in details. Garrison talks of triangles pulled at both ends, but it's a metaphor, not a theory. He also talks of money illusion by part of workers, which can cause overproduction. Hayek and Machlup occasionally talk about undermaintenance of capital, increased exploitation of capital goods, shifts from long-term to short-term production at the top of the boom (Ricardo effect). However, to my knowledge this is a work in progress, not a full-blown theory.
However, don’t lose time with my comments. O’Driscoll, Woolsey, Koppl and many others have given life to a wonderful thread.
mercoledì 31 marzo 2010
Rational irrationality
The comments of this post from Coordination Problem are interesting, especially - as usual - O'Driscoll's. The topic is Bryan Caplan's theory of rational irrationality. There is also a comment of mine, but O'Driscoll's comments make it outdated. I think I will think about the issue during the holidays.
Just a small summary of Caplan's argument (I bet my language is different: I've never studied public choice seriously, I'm Austrian, and I read the book "The myth of the rational voter" more than one year ago).
The objections raised in the comments are:
Just a small summary of Caplan's argument (I bet my language is different: I've never studied public choice seriously, I'm Austrian, and I read the book "The myth of the rational voter" more than one year ago).
- If I believe that gravity doesn't exist and I jump off a bridge, I die. That's the cost of being irrational, which is particularly strong in real "private" life.
- Where's this feedback mechanism in politics? Each single voter has a 0.0000001% probability of being relevant at the margin at the elections. The benefits of informed and rational choices are public, the costs are private: reasonableness is a public good. Rationality is systematically underproduced, because rational politics from the point of view of the voters is a tragedy of the common.
The objections raised in the comments are:
- Organized political groups are competitive and will invest in "rationalizing" the voters.
- Economists don't invest in laymen's education: when they did it, voters were more rational.
Is money a present or future good?
This morning I read "credit creation or financial intermediation?" by Cochran, Call and Glahe (QJAE).
The paper precisely hits one point of disagreement in the monetary disequilibrium vs injection effects debate, which divides the orthodox Austrian camp (Mises, Hayek, Rothbard,...) and a new brand of Austrian-monetarist synthesis whose most important proponent is Horwitz (Microfoundations for microeconomics), and is at the root of the works of Warburton, Yeager, Selgin, White, and Sechrest.
The two theories appear to differ on many aspects, some of them of purely ideological and noneconomical nature, and some of theoretical interest: is free banking feasible?, is money a present or future good? are injection effects or price rigidities responsible for monetary non-neutrality? is the law of reflux a feasible way to enable a proper use of voluntary saving?
Today I want to talk about the issue of presentness, because I consider both camps to be wrong (which means that the only right explanation is to be found in this blog, and this adds to the unlikeliness of its reliability):
< X < 1 of it, it is immobilizing X$ worth of real resources (assuming constant prices) for an investment project. The moneyholder, however, doesn't lose the availability of his spending power, so that it has not yet decided whether he will consume or not. The bank is right in lending the deposit if the consumer won't exercise his option of using his money to buy consumers' goods before the investment is liquidated. The bank is wrong if the option is exercised before final liquidation, because it will have to ask for credit to pay for something that was not intended as credit. If all the banks at once immobilize more money than money holders are willing to consider as real saving, the banks will run out of liquidity and a crisis will ensue. This is not a liquidity crisis: it is a real crisis, because it is the command over real resources that is not available, not liquidity per se, at least if money doesn't depreciate (i.e., if a firm and a consumer want the same commodity, this is real scarcity, it is not a monetary problem). Of course, the banks can reduce the real value of their monetary liabilities in order to avoid running out of liquidity by printing more money. This is exactly what happens under central banking. However, without a public safety net I don't believe that this behaviour would be feasible, other than in the shortest run: there are limitations to monetary devaluation in that outside money cannot be printed, as it is commodity money.
This is not an analysis of the business cycle, becasue, to say the least:
The error in the monetary equilibrium analysis is to confuse a tautology (money holding is saving now, as there is no consumption) with the real economic issue (in order to avoid problems, money holding will have to be saving from now to the end of the underlying investment).
At this point, a question must be raised about how banks can distinguish between real saving (in the economically relevant sense, i.e., over an horizong linked to the time structure of production, which in monetary equilibrium analysis is never considered) and merely instantaneously foregone consumption. I know of no reliable answer to this question, maybe because, in the literature I know, both "presentists" and "futurists" don't see the problem in these terms.
The paper precisely hits one point of disagreement in the monetary disequilibrium vs injection effects debate, which divides the orthodox Austrian camp (Mises, Hayek, Rothbard,...) and a new brand of Austrian-monetarist synthesis whose most important proponent is Horwitz (Microfoundations for microeconomics), and is at the root of the works of Warburton, Yeager, Selgin, White, and Sechrest.
The two theories appear to differ on many aspects, some of them of purely ideological and noneconomical nature, and some of theoretical interest: is free banking feasible?, is money a present or future good? are injection effects or price rigidities responsible for monetary non-neutrality? is the law of reflux a feasible way to enable a proper use of voluntary saving?
Today I want to talk about the issue of presentness, because I consider both camps to be wrong (which means that the only right explanation is to be found in this blog, and this adds to the unlikeliness of its reliability):
- Cochran says that there is no cost in money holding, in terms of foregone consumption, because money can be used without any delay: money is a present good.
- Horwitz says that money holding is saving, because it is not consumption.
- I say that money holding is neither of the two.
This is not an analysis of the business cycle, becasue, to say the least:
a distinction between real and nominal movements should be done: if prices were perfectly flexible, market coordination were instantaneous, and monetary movements had no distributive effects... money would only be a nominal issue, of no interest for economics (this is unlikely, of course), not all banking crises result in inflation, so that an analysis of deflationary crises is necessary (there is no mystery here: credit and monetary aggregates are countercyclical, so not all crises result in devaluation, a stop in the credit creation process suffices to create a crisis when the underlying market structure is unsustainable, and its reversal adds to it).
The error in the monetary equilibrium analysis is to confuse a tautology (money holding is saving now, as there is no consumption) with the real economic issue (in order to avoid problems, money holding will have to be saving from now to the end of the underlying investment).
At this point, a question must be raised about how banks can distinguish between real saving (in the economically relevant sense, i.e., over an horizong linked to the time structure of production, which in monetary equilibrium analysis is never considered) and merely instantaneously foregone consumption. I know of no reliable answer to this question, maybe because, in the literature I know, both "presentists" and "futurists" don't see the problem in these terms.
sabato 13 marzo 2010
Counterfactuals
Uh, this morning I've understood another small element of the edifice of economic theory.
Here's my comment (on this post by Prof. Rizzo) which shows the intuition:
Moral hazard is not only relevant because of deposit insurance: it is relevant whenever costs are socialized.
If I invest too much now, together with everybody else, in a private-costs world I would expect high interest rates in the future, when there will be a scramble for credit, i.e., investment that raises the demand for capital, as Hayek put it.
When there is the central bank following a countercyclical monetary policy, during the scramble for capital, normally, interest rates don't rise in the short run, and probably also in the long run (the policy intervention will be at least as persistent as the crisis, i.e., the scramble for credit).
Counterfactually, an interest rate that in a private-costs world would have risen to 7-8% at the onset of the crisis, becomes a 0% interest rate because of the central bank. This may be imply great cost socialization… as the counterfactual market interest rate is not observable, however, it is difficult to evaluate if the phenomeon is relevant.
When costs are socialized, the market system is uncapable of retrieving and spreading correct information and forcing correct incentives. All the coordination process goes astray.
Competitive market agents will take moral hazard into account and “optimize” taking the cost socialization technology into account, i.e., they won’t “optimize” to find a “social optimum”, whatever it means.
Systemic risk cannot be avoided because noone has private incentives to avoid it. Only monetary authorities can stop socializing risks, but countercyclical policies work on the opposite principle.
Here's my comment (on this post by Prof. Rizzo) which shows the intuition:
Moral hazard is not only relevant because of deposit insurance: it is relevant whenever costs are socialized.
If I invest too much now, together with everybody else, in a private-costs world I would expect high interest rates in the future, when there will be a scramble for credit, i.e., investment that raises the demand for capital, as Hayek put it.
When there is the central bank following a countercyclical monetary policy, during the scramble for capital, normally, interest rates don't rise in the short run, and probably also in the long run (the policy intervention will be at least as persistent as the crisis, i.e., the scramble for credit).
Counterfactually, an interest rate that in a private-costs world would have risen to 7-8% at the onset of the crisis, becomes a 0% interest rate because of the central bank. This may be imply great cost socialization… as the counterfactual market interest rate is not observable, however, it is difficult to evaluate if the phenomeon is relevant.
When costs are socialized, the market system is uncapable of retrieving and spreading correct information and forcing correct incentives. All the coordination process goes astray.
Competitive market agents will take moral hazard into account and “optimize” taking the cost socialization technology into account, i.e., they won’t “optimize” to find a “social optimum”, whatever it means.
Systemic risk cannot be avoided because noone has private incentives to avoid it. Only monetary authorities can stop socializing risks, but countercyclical policies work on the opposite principle.
Ebeling on Mises
This post by Ebeling on Coordination Problem is very interesting and well worth reading.
Mises's epistemology was characterized by a dichotomy: Theory and History. The epistemic properties of the two realms of social inquiry were opposite. I think that it is better to use a Husserlian terminology and call them "research of essence" and "research of existence": the former, Theory, is about logical relations among concepts, the latter, History, is about all the complications which arise when it comes to apply Theory to the real world.
The hyperrationalist interpretation of Mises, which I think was due both to Rothbard (in which constructivism and apriorism play important ideological functions) and Hayek (for instance, when he said that Mises's "Socialism" was a great and influential work, but too rationalistic), is not compatible with what Mises writes, with or without the additional important insights which Prof. Ebeling has added with his post (which I'm looking forward to reading in the referenced books by the Liberty Fund).
Without History, what remains of Mises is a delusional hyperrationalist who thinks to be able to derive propositions about the real world out of purely logical constructs. This interpretation is not consistent with Mises's writings, in which the dichotomy between Theory and History hides all the uncertainty of the real world in the latter camp. Mises claimed explicitly that the apriori may have had an evolutional origin, that all theories are incomplete and subject to radical changes, that all the rational constructs are based on more or less arbitrarily chosen "ultimate givens". Where's the hyperrational? To have clear ideas and to state them clearly cannot be a symptom of hyperrationalism.
Let's make an example: socialism is impossible because there cannot be monetary calculations AND monetary calculations are necessary for coordinating a complex economy. The last hypothesis is not apriori: it is an empirical generalization of very vast applicability.
There are cases in which empirical hypotheses, which are logically necessary to apply Theory to History (essence does not beget existence, Saint Anselm notwithstanding), are not as clearcut. While it can be claimed that reality is complex, production takes time, capital is heterogeneous and information is scarce without fear of being falsified on a posteriori grounds, it cannot be said with the same level of certainty that the structure of production is sustainable or not, if a boom is fundamentally sound or will be turned into a bust, whether economic agents are conned into believing, or acting as if, something is true when it is not...
Relevance is never a priori concept: it is an a posteriori judgement about the relative importance of several conceivable causal factors in the interpretation of a specific historical event.
Mises's epistemology was characterized by a dichotomy: Theory and History. The epistemic properties of the two realms of social inquiry were opposite. I think that it is better to use a Husserlian terminology and call them "research of essence" and "research of existence": the former, Theory, is about logical relations among concepts, the latter, History, is about all the complications which arise when it comes to apply Theory to the real world.
The hyperrationalist interpretation of Mises, which I think was due both to Rothbard (in which constructivism and apriorism play important ideological functions) and Hayek (for instance, when he said that Mises's "Socialism" was a great and influential work, but too rationalistic), is not compatible with what Mises writes, with or without the additional important insights which Prof. Ebeling has added with his post (which I'm looking forward to reading in the referenced books by the Liberty Fund).
Without History, what remains of Mises is a delusional hyperrationalist who thinks to be able to derive propositions about the real world out of purely logical constructs. This interpretation is not consistent with Mises's writings, in which the dichotomy between Theory and History hides all the uncertainty of the real world in the latter camp. Mises claimed explicitly that the apriori may have had an evolutional origin, that all theories are incomplete and subject to radical changes, that all the rational constructs are based on more or less arbitrarily chosen "ultimate givens". Where's the hyperrational? To have clear ideas and to state them clearly cannot be a symptom of hyperrationalism.
Let's make an example: socialism is impossible because there cannot be monetary calculations AND monetary calculations are necessary for coordinating a complex economy. The last hypothesis is not apriori: it is an empirical generalization of very vast applicability.
There are cases in which empirical hypotheses, which are logically necessary to apply Theory to History (essence does not beget existence, Saint Anselm notwithstanding), are not as clearcut. While it can be claimed that reality is complex, production takes time, capital is heterogeneous and information is scarce without fear of being falsified on a posteriori grounds, it cannot be said with the same level of certainty that the structure of production is sustainable or not, if a boom is fundamentally sound or will be turned into a bust, whether economic agents are conned into believing, or acting as if, something is true when it is not...
Relevance is never a priori concept: it is an a posteriori judgement about the relative importance of several conceivable causal factors in the interpretation of a specific historical event.
giovedì 11 marzo 2010
My reading skills fail me
I was asking a question to Prof. O'Driscoll on this Prof. Boettke's post on the public choice dangers of monetary policy (post and comments strongly suggested). Then I realized that I didn't understand its comment, as I thought he was saying that the Fed has sterilized monetary interventions in Fall 2008 (instead of BEFORE Fall 2008).
However, this is a 15m work on Fed FRED data, and I post it as a summary.
Fed Policies in Fall 2008.
Target interest rates: in Fall 2008 it fell from 2 to 0. This is expansionary.
Monetary base: in Fall 2008 it came from 850 to 1700b$. This is expansionary, too. Quantitative easing implies that monetization is not sterilized, otherwise is a portfolio rebalance (buy toxic waste, sell t-bills). The Fed would have run out of good collateral.
Extra facilities like TAF, TALF, MMIFF, AMLF, CPFF, created from Summer 2008 to Fall 2008, created reserves. I'm quite sure about that regarding TAF (and the already existing, in Fall 2008, PDCF), the others are a little bit to complicated for me. The already existing TSLF was not a monetary facility, but a credit transformation facility.
One element remains out of sync with the other policies: interest payments on deposits at the Fed, started in mid Oct 2008.
However, this rate fell to zero (dot something) after two months of existence, so I wouldn't consider it relevant at the margin: it's a 0.0025 * M0 gift for the banks, i.e., less than 5b$/y.
If return rates were not (risk adjusted) zero elsewhere in the economy, the substitution effect would have been quite nil. If they were zero elsewhere in the economy (like in New Keynesian ZIRP models with negative real natural rates), this is what has to be explained.
Besides, the CPI started falling before interest payments on reserve (July 2007), and deflation accelerated in September 2008, before interest on reserves. Inflation turned back in early 2009, so the eventual effect of this policy on the CPI was very short lived, if existent.
Interest on reserves is somehow a mystery, and I can only explain it as fear of inflation, but with 0.25% interest paid, I think it's also practically irrelevant.
Why did they do it? The standard answer is "to enlarge the Fed balance sheet without losing high quality collateral, i.e. t-bills", but why did they feared this? Just expand M0 as if there is no tomorrow. Japan already did it, and with zero effect (it makes the public debt marginally less expensive and it helps overvaluing toxic waste).
However, this is a 15m work on Fed FRED data, and I post it as a summary.
Fed Policies in Fall 2008.
Target interest rates: in Fall 2008 it fell from 2 to 0. This is expansionary.
Monetary base: in Fall 2008 it came from 850 to 1700b$. This is expansionary, too. Quantitative easing implies that monetization is not sterilized, otherwise is a portfolio rebalance (buy toxic waste, sell t-bills). The Fed would have run out of good collateral.
Extra facilities like TAF, TALF, MMIFF, AMLF, CPFF, created from Summer 2008 to Fall 2008, created reserves. I'm quite sure about that regarding TAF (and the already existing, in Fall 2008, PDCF), the others are a little bit to complicated for me. The already existing TSLF was not a monetary facility, but a credit transformation facility.
One element remains out of sync with the other policies: interest payments on deposits at the Fed, started in mid Oct 2008.
However, this rate fell to zero (dot something) after two months of existence, so I wouldn't consider it relevant at the margin: it's a 0.0025 * M0 gift for the banks, i.e., less than 5b$/y.
If return rates were not (risk adjusted) zero elsewhere in the economy, the substitution effect would have been quite nil. If they were zero elsewhere in the economy (like in New Keynesian ZIRP models with negative real natural rates), this is what has to be explained.
Besides, the CPI started falling before interest payments on reserve (July 2007), and deflation accelerated in September 2008, before interest on reserves. Inflation turned back in early 2009, so the eventual effect of this policy on the CPI was very short lived, if existent.
Interest on reserves is somehow a mystery, and I can only explain it as fear of inflation, but with 0.25% interest paid, I think it's also practically irrelevant.
Why did they do it? The standard answer is "to enlarge the Fed balance sheet without losing high quality collateral, i.e. t-bills", but why did they feared this? Just expand M0 as if there is no tomorrow. Japan already did it, and with zero effect (it makes the public debt marginally less expensive and it helps overvaluing toxic waste).
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