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Saturday, August 18, 2012

Jonathan Finegold Catalán: A Double Agent?

You'd think he is a Hayekian, but then you read:

"In other words, even if the rate of interest is higher than what it should be given society’s time preference, the prices of the factors of production will reflect total aggregate demand for them. That is, the prices of the means of production would be lower than they would be if the rate of interest were lower."

And what about when the rate of interest is lower than it should be, say... due to central bank policy? Presumably, the prices of the factors of production will rise until they correctly reflect total aggregate demand for them.

So the Mises-Hayek boom will never happen. In what is purportedly an effort to defease Keynes, Jonathan has just declared the Austrian theory of the business cycle out of bounds as a reasonable theory of the cycle. Sneaky!

(Just winding you up a bit, Jonathan!)

16 comments:

  1. Well, that is only true if you disregard what is unsaid.

    For instance, a credit expansion will surely cause a decrease in the demand to hold money, as well as the effects of diminishing marginal utility associated with that money (i.e. the bidding up of prices leading to malinvestment). John is essentially saying that if the rate of interest is higher than time preference, then the tendency would be to bid down the prices of the factors, eventually settling at an equilibrium price in the aggregate. This is pretty much an innocuous and hypothetical situation, because while it certainly can misallocate the factors, the penchant for overconsumption isn't present (as compared to the available capital), and thus the tendency would be more toward not using capital to its fullest capabilities (some of it might set idle).

    However, in the opposite case, where the prices of factors are being bid up and consumption is steady or even increasing, that is where malinvestment truly finds its home: it still leads entrepreneurs to take actions that they otherwise would not have taken, but it doesn't represent a surplus supply of factors for the demand of scarce resources.

    However, the real question is this: When has a central bank ever increases the rate of interest above that dictated by time preference? Obviously, we can't objectively measure such a thing, but it goes without saying that this has never been a policy of any central bank that I am familiar with. Both cause malinvestment, it is just a matter of whether the factors of production are being used in a way that is unsustainable in terms of resources, or whether it is a glut of available factors.

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    1. Volcker's policy might have brought interest rates to that level. Just doing some quick and dirty calculations from FRED data. (Federal Funds rate - CPI) to get an approximation of real rates yields (pun intended), about 0% in 1980, 6% in 81, 82, and 83 and slowly decreasing from then on. Mid 81 had about an 8% rate which is pretty high. Higher than the natural market rate? I don't know, but it would be interesting to see if any of the effects of an artificially high interest you posit, were present.

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    2. The problem is that there really is no way to know what the natural rate of interest is. I mean, we can stop tinkering with the interest rate completely, then we'd have a better idea. But as far as Volker is concerned, it still could have been the case that he set the interest rate below that of the natural rate of interest, even if he set the interest rate pretty high (which he did).

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  2. In other words, both represent examples of malinvestment. However, one represents a demand for factors that is unsustainable given the limited resources available, whereas the other represents a less unsustainable path, but with plentiful availability of resources. I would imagine that the inevitable "bust" would play out exactly the same, but in completely opposite directions. The real takeaway in my opinion is to not mess with the interest rate through central planning measures, because you change the course of investment and utilization from what it would have otherwise been given the real availability of resources and factors in the economy.

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    1. Joseph, see my reply to Jonathan below: it is not that I disagree with anything you write above, but that it misses just what I am criticizing about Jonathan's view.

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    2. Ah, my position apparently is much different than Jonathan's, or at least your interpretation of it. My position is that no matter which way the interest rate is manipulated that it will create the misallocation of resources. Jonathan seems to be saying that it won't in the case of an interest rate higher than that determined by market time preference, that prices would adjust accordingly. Is that the gist of what you're laying down?

      Personally, I usually think of interest rate tinkerings in terms of price controls, only superimposed upon the capital structure. Prices of factors are certainly important, but they are instantaneous, whereas the interest rate deals in the use of resources over time. While prices can change on a dime, the availability of resources cannot.

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  3. Gene,

    An increase in the price of the factors of production is a key characteristic of the boom. The problem that Mises and Hayek see is that these prices are sustained by monetary injections, and so when new money ceases to flow into these areas of investment the "phantom profits" will disappear and the investments will turn unprofitable.

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    1. "An increase in the price of the factors of production is a key characteristic of the boom."

      Jonathan,

      1) Don't try to teach your grandfather to suck eggs. I published a very extensive empirical documentation of this phenomenon with Garrison in 2003.

      2) The point doesn't help your case at all. To dismiss Keynes, you say, "If the interest rate is too high, no matter: capital goods prices will adjust swiftly enough that we will never see a problem."

      But the Mises-Hayek story requires that they adjust to low interest rates only with a large enough lag that huge macro problems are created.

      My point is I don't see why you believe you can have it either way -- quick, painless adjustments when convenient, or slow, painful ones when you want that.

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    2. Suck eggs???

      Must be an old guy thing.

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    3. Gene,

      My point is that a fall in the price of capital goods will sustain the rate of investment. As you know, "sustaining the rate of investment" is not the crux of the Mises-Hayek theory. It's not an overinvestment theory, it's a malinvestment one.

      So, I'm not sure how my comment suggests that the Mises-Hayek business cycle isn't a problem. The prices of capital goods do increase. The problem isn't the change in prices, but of temporary profits caused by temporary money injections.

      In fact, the rate of interest is so secondary in Hayek's theory, that in his response to Sraffa's review in 1932, Hayek emphasizes the importance of "phantom profits" over the interest debate.

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    4. Jonathan,
      I am not very well-read on Hayek. I've read some of his work, but not enough to have a grasp on his version of cycle theory. Is his theory of phantom profits related to price imputation? For instance, is his theory that there is a price discoordination between consumer goods and the factors that produce them, thus when the market adjusts the prices of factors back to reflect their real inputed value that this is when phantom profits are revealed?

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    5. 1) Don't try to teach your grandfather to suck eggs. I published a very extensive empirical documentation of this phenomenon with Garrison in 2003.

      This is a pretty off-putting remark, Gene. It is unpleasant enough when non-Austrian economists attempt to pull rank on Austrians in order to defeat their arguments. It is beyond the pale for Austrians to do so among each other.

      Eliminating your point (1) from your comment entirely wouldn't change its argumentative value at all.

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    6. This is a pretty off-putting comment, Ryan, because there was no "pulling rank" involved! Jonathan had "informed" me that the price of capital goods would go up in the Mises-Hayek story of the boom. I responded, essentially, "Come on, Jonathan, please don't 'inform' me of things I wrote about 9 years ago."

      That is not "pulling rank" at all. It is just letting Jonathan know he was being a bit silly in "informing" me of this fact.

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  4. Daniel, stupid &)(:;;! Blogger won't let me paste into comment boxes from my phone, but if I mail you the link explaining "suck eggs" perhaps you can paste it in here?

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  5. http://en.m.wikipedia.org/wiki/Teaching_grandmother_to_suck_eggs

    I may or may not have vaguely remembered hearing it before, not knowing exactly what it meant, and taken the opportunity to rib Gene.

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  6. "Presumably, the prices of the factors of production will rise until they correctly reflect total aggregate demand for them."

    Isn't this precisely what will happen in ABCT ? Lower interest rates make longer term investments more attractive, causing total aggregate demand for the capital goods used to produce them to go up, driving up their prices above what they would be in equilibrium.

    While lags in price adjustments are undoubtedly needed to make ABCT credible I do not believe that lags in the prices changes for longer times capital goods are a requirement.

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