Garrison's Business Cycle as an Overproduction Theory

In my continually rethinking of cycle issues, I have come to the conclusion that Roger Garrison's cycle theory ought to liberate itself from its Hayekian triangles and stand on its own as a theory of a temporary movement beyond the production possibilities frontier.

Garrison defines his PPF as a sustainable combination of output. How can we move beyond that? A story as simple as this will do: Let's say we own a factory that produces some investment good. Our normal schedule is to run the machines in the factory 20 hours per day, allowing four huors for them to cool down and to be repaired. But the good we produce becomes in great demand for some consumption good it is used to produce. We could invest in more machines, but instead we decide to "make hay while the sun shines": we run our machines 24 hours a day, with no maintenance or cool down periods.

For some time, the production of both investment and consumption goods may rise. That is the "boom." But this cannot last: after two months, all of our machines begin breaking down. That, of course, is the "bust."

How do the interest rate and the capital structure relate to this simple story? That is the subject of our next post.

21 comments:

  1. "For some time, the production of both investment and consumption goods may rise. That is the "boom." But this cannot last: after two months, all of our machines begin breaking down. That, of course, is the "bust.""

    Even if he machine didn't break down mechanically there would still be a bust though - when it turned out the prices (and the expectations of future prices) that existed during the bust are unsustainable.

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    1. But *why* are they unsustainable? There needs to be a *real* (not monetary) explanation of what has gone wrong, otherwise why shouldn't those simply *be* the new prices?

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  2. I really need to re-read Time and Money. But, something that doesn't strike me as correct is Garrison's formulation of ABCT as positing a temporary unsustainable increase in output beyond the PPF. In the original Hayekian version production of consumers' goods is sacrificed for production of producers' goods, but we're still on the same PPF. In Garrison's model, IIRC, production of earlier producers' goods and consumers' goods is done at the expense of the middle stages of production -- but we're still on the PPF. I also have trouble seeing how Garrison's model would lead to a boom-bust. But, I have to re-read the book.

    I'll have to think about this over the weekend. Coincidentally, thinking about the original Hayekian model, an increase in fiduciary media must be used to consume, because if we assume that in equilibrium MC=MB, then there are no profits until ↑M leads to ↑D. An increase in demand for goods of the final stage will induce investment in this stage, but this will draw resources from earlier stages. So yes, an increase in credit will change the structure of production, but it should make the economy as a whole less capital intensive, not more capital intensive. Either I'm thinking through this without care, or this is a big obstacle for the theory. (I don't remember right now -- I'll have to check later -- but this may have been Hicks' critique of the theory.)

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    1. "In the original Hayekian version production of consumers' goods is sacrificed for production of producers' goods, but we're still on the same PPF."

      Right. But it is now well-known that there is co-movement of investment and production.

      "In Garrison's model, IIRC, production of earlier producers' goods and consumers' goods is done at the expense of the middle stages of production -- but we're still on the PPF."

      No, that is definitely incorrect. See: http://mises.org/journals/qjae/pdf/qjae6_2_3.pdf -- We had a whole section called "Beyond the PPF."

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    2. "But it is now well-known that there is co-movement of investment and production."

      Oops. I meant "consumption," of course.

      Here is a quote from our paper: 'Garrison (2001, p. 70) asks: “Is it possible for the economy to produce
      beyond the production possibilities frontier?” He answers, “Yes, if the PPF is defined as sustainable combinations of consumption and investment."'

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    3. I'll have to read that paper over the weekend. But, if that's how the PPF curve is defined, then it shouldn't look like a textbook PPF curve (it should be only a specific arc, or set of arcs, of the original curve). And, the only way to move "beyond" the curve is to move up or down the curve into zones that are left out because they're unsustainable.

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  3. OK. Ignoring interest rate and the capital structure (ABCT)just like you did.

    - The money supply increases causing people to feel richer and spend more on consumer goods

    - This allows businesses to both raise prices and produce more. They get workers to work harder but don't at this stage raise wages, and turn their machine on for longer like you say. There is a boom caused by profits being bigger than before due to output prices increasing ahead of input prices

    - Eventually competition for labor and other inputs pushes up their prices too. Relative prices readjust and the boom proves unsustainable.

    - I'm not sure what machines breaking down add to this story. Had the boom been driven by a sudden but sustainable increase in demand for consumer goods then businesses still would have increased output in the short term and caused machines to wear-out faster while they awaited an increase in the production of machines that produce consumer goods. In this the case the increase in output would be sustainable though.

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    1. "OK. Ignoring interest rate and the capital structure (ABCT)just like you did."

      But I am not "ignoring" them: just not discussing them right at present. I very explicitly promised they were coming!

      "Eventually competition for labor and other inputs pushes up their prices too. Relative prices readjust and the boom proves unsustainable."

      OK: You have explained why growth goes up for a while, then drops back down to normal. Why is there a bust?

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    2. That's where "interest rate and the capital structure " comes back in !

      But even without that - if businesses seeing the boom started to invest on the assumption it was permanent - that could cause a bust when prices start to adjust.

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    3. " that could cause a bust when prices start to adjust."

      Why?

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    4. Because people who had over-invested in the boom will face losses. This will cause them to reduce their spending and fire some workers. This will cumulatively cause demand to fall further. This could cause others to become more pessimistic and spend less for purely precautionary reasons, banks to cut back on lending and so on.


      This would be the bust.

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    5. Of course logically there is no inevitability of a bust. At any moment if the economy could magically find a new equilibrium there would be no bust. But the dynamics of the economy mean that things tend not to adjust that smoothly , especially when one considers psychological factors - which is why the boom is likely to be followed by a bust.

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    6. But WHY will they face losses, Rob? What does "over-investment" mean here? (I am trying to push you towards seeing the importance of capital structure in this story.)

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    7. I was deliberately leaving capital structure out (as I believe that you can get boom/bust purely via monetary expansion without looking at how this expansion would affect interest rates and the structure of production).

      Obviously if one adds that back in you get ABCT - where the structure of production is rendered non-optimal by the effects on interest rates of monetary expansion. This adds to the unsustainability of a boom induced by an unexpected increase in the money supply.

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    8. "But WHY will they face losses"

      The answer to this is simple: because there expectations about future prices proved to be incorrect to such a degree that their costs ended up greater than their revenues.

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  4. Hi Gene,

    I have a question, kind of unrelated to this post specifically. I'm a heterodox graduate economics student interested in Austrian theories of production. What would you recommend that I read?

    Thanks

    CMD

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  5. Lachmann. Lewin. Baetjer.

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  6. Dr. Callahan,

    You have worked with Garrison before, why don't you ask him what he thinks of your new opinion regarding his business cycle theory and then let us know what he thinks?

    Senyor

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  7. Dr. Callahan,

    You have worked with Garrison before, why don't you ask him what he thinks of your new opinion regarding his business cycle theory and then let us know what he thinks?

    Senyor

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    1. Senyor, as I develop my thoughts here, I most definitely intend to run them by Roger!

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