Wednesday, August 25, 2010

Krugman's Willful Distortion of the Austrian Theory of the Business Cycle

Once again, Paul Krugman creates a caricature of the Austrian Theory of the Business Cycle, calling it the "Hangover Theory," and then continues to misrepresent what it says and what its adherents say in their analysis of the boom and bust cycles. His recent blog post continues this dishonesty.

Before dealing directly with his accusations about the ATBC, I will note that both David Gordon and Robert Murphy do credible jobs in debunking Krugman's misrepresentations. I will add briefly to what they already have written.

Krugman declares:
...one more thing struck me: at least some members of the FOMC have bought into the hangover theory — the modern version of liquidationism in which mass unemployment is somehow necessary in the aftermath of a burst bubble....
This is an important point, because while Austrians are adamant that malinvested resources and capital that were created or advanced during the boom are NOT sustainable during the crisis and the subsequent bust. (Krugman, it should be noted, insists on saying that Austrians, such as Nobel-Prize Laureate F.A. Hayek, push an "overinvestment" theory when, in fact, the Austrians have dealt with that very term and have said it is not an appropriate one in the ATBC. In other words, even though Austrians address that very word, Krugman still pretends as though they have not done so.)

Furthermore, Austrians, unlike Keynesians, who believe that factors of production generally are homogeneous and are equally affected by new injections of spending, look carefully at the issues of the factors, for what is where the result of the downturn are concentrated. Furthermore, NO Austrian calls for some sort of "general liquidation" of the economy. Instead, Austrians hold that those investments in capital and other factors that no longer are sustainable should be liquidated or transferred to other uses for which there clearly is consumer demand. This is a far cry from Krugman's point.

I know of NO Austrian who claims that "mass unemployment is somehow necessary in the aftermath of a burst bubble," none. Austrians say that if there is mass unemployment (and especially if that unemployment is chronic) we can look to government intervention as the reason. Rothbard, in America's Great Depression, writes:
If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don't interfere with the market's adjustment process. The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite "anti-depression" arsenal of government policy. (Emphasis mine)
Rothbard then explains the policies that are most harmful:
1. Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.

2. Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government "easy money" policy prevents the market's return to the necessary higher interest rates.

3. Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.

4. Keep prices up. Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.

5. Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by "food stamp plans" and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed.[15] Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.

6. Subsidize unemployment. Any subsidization of unemployment (via unemployment "insurance," relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available.
Interestingly, ALL of these things listed above are precisely what Krugman claims will END the downturn. Yet, we have seen government do these things in spades, yet the economy continues to tank. Rothbard clearly notes that mass unemployment, and especially mass unemployment over a long period of time, is NOT necessary, but generally occurs because of government intervention, not in spite of it.

So what does Krugman do? He claims that the REAL problem is that government did not spend enough, regulate enough, tax enough, jack up wages past marginal productivity levels, and subsidize enough unproductive industries (i.e. "green" jobs). And when the economy continues to tank, he creates a caricature of the only business cycle theory that accurately explains what is happening, and then builds a series of falsehoods from there. Just another day at the office for Paul Krugman.

20 comments:

burkll13 said...

[sarcasm] But, but, but,... government spending DOES promote savings because, you know, without the government providing a mechanism to save, it wouldnt happen!! [/sarcasm]

Anonymous said...

Keynesians are incapable of understanding the Austrians because they have no capital theory. Krugman can't understand how consumption and investment could increase at the same time (through capital consumption). This lack of understanding is also behind the ridiculous opinion that if people spend less, business has to fire people, those people spend less, more people are fired, etc.

Nick C said...

As a chemical engineer in the microelectronics industry, I see this all the time. Sometimes we do well and other times we do not. We are currently expanding our production with used equipment purchased on the secondary market to keep up with the smartphone growth. But, In a few years, our business may go down the tubes and we will have sell it off to recoup costs associated with maintaining that equipment or even close the whole factory if we can't compete.

That is the natural way of things.

Bob Roddis said...

Krugman has no intention of making a sound argument here. He is solely concerned with using his NYT forum to deem Austrian School advocates as social pariahs and their arguments beyond the pale with “the smart set”. Recall his “banana fungus” post? Krugman’s a pathetic sissy, a vicious little thug and a person of extremely low character.

As with our Charlatan Chartalists, no “critic” of the Austrian School, such as Krugman and the Keynesians, has the slightest familiarity with either the basic or broad concepts of the Austrian School. Notice how no critic ever argues “Heck no. People don’t ACT! And they don’t have their very own set of subjective values”. Instead, they scream “OMG. You have AXIOMS!!!! Fringe Fringe Fringe!”

Human action and subjective valuation lead to economic calculation. The foundation of the capital structure is economic calculation. See “The Capitalist and the Entrepreneur” by Peter Klein.
As Robert Wenzel points out, you can’t interpret economic data without reference to human action. And this entire discussion flies right over the head of the Keynesian and Chartalist.

BTW, I’d pay to see Wenzel’s reaction to being told by a Chartalist that Wenzel doesn’t understand our monetary system.

AP Lerner said...

“His recent blog post continues this dishonesty.”

Sorry, but you are in not position to call anyone dishonest after this rubbish you wrote June 22, 2010

http://krugman-in-wonderland.blogspot.com/search?q=ponzi

or this rubbish

http://krugman-in-wonderland.blogspot.com/search?q=ireland

Maybe you could explain the factors of production that were behind the consumer taking on debt that is 130% of their income? How do we eliminate that malinvestment? Maybe someone can explain how raising taxes or firing a bunch of government workers and draining additional income from the public sector will reduce the debt to income levels of the private sector? Right because this graph actually does not exist.

http://images.creditwritedowns.com/wp-content/uploads/2010/07/Pimcos_double_entry_bookkeeping.gif

It’s made up. It’s an illusion. Cutting taxes does nothing for private sector. Cutting taxes cannot possible add savings to the private sector.

Of course, anyone that has been paying attention the last few years and understands the monetary system of the US, knows this is not a recession caused by malinvestment in an industry and all we need to do is let deflation works it’s magic and the economy will heal. It’s not 2002. It’s not 1992. It’s not 1982. This is, of course, a balance sheet recession. Debt must be destroyed, and the government with it's rush towards austerity is causing more harm. By claiming the public deficit must be shrunk now, now, now, you do realize you are asking for government intervention in the economy, right? And government intervention is always a bad thing, right?

“He claims that the REAL problem is that government did not spend enough”

You’re funded by the government. I can only assume you are no longer taking a paycheck in the name of reducing malvinvestment, right?

FYI – 10 yr. treasury yields now at 2.47%. Prof. Anderson and Peter Schiff were 100% accurate. Bankruptcy is eminent. Ireland is booming. Austerity was great for their economy. They clearly know what they are talking about. All the empirical evidence is on their side.

Maybe someone can explain why Austrians do not believe in empirical evidence? Or maybe someone can give an explanation why treasurie yields keep falling if the US is such a credit risk?

Bob Roddis said...

Maybe you could explain the factors of production that were behind the consumer taking on debt that is 130% of their income? How do we eliminate that malinvestment?

1. Funny money bid up the price of homes. This was based on the theft of purchasing power of those holding existing money. In order to stay ahead of the Fed's program money dilution through loans, people needed a store of value and bought real estate. Further money dilution made prices rise even further. People took out "equity loans" on their increased “equity”. However, there really weren't buyers out there with $700,000 in real stuff to trade for a former $100,000 house. Since stuff trades for stuff, the funny money regime impaired economic calculation. That's how it happened.

2. Malinvestments are investments in lines of the production of stuff no one wants. When you can't sell your stuff, you move on. You are no position morally to steal stuff from others to prop up the malinvestors. Pretty simple.

Maybe someone can explain how raising taxes or firing a bunch of government workers and draining additional income from the public sector will reduce the debt to income levels of the private sector?

No one here advocates raising taxes.

You seem oblivious to the concept of “scarce resources”. If you have a bunch of donut-eating cops and lying prosecutors drawing high salaries, benefits and pensions, they need to get their claims on scarce resources from somewhere. So they are paid with money extracted from the people who earned the money. The people who actually earned the income should keep their money and retain their claims on those resources and the donut eaters can go out a find a more needed line of work. Certainly, under that scenario, the taxpayer is better off. Who cares about the donut eaters? They can find a real job.

The concept of a “balance sheet recession” makes no sense. Where’s your analysis of human action in your claims? You don’t know I’m saying and you don’t know what you’re saying.

Bob Roddis said...


Robert Wenzel writes:


Treasury Five Year Note Auction at Lowest Rate Ever
1.374%

Just understand: We are bordering on the edge of massive debt and, thus, potential huge inflation. There will be months with inflation rates greater than 1.374%. I do not classify locking in 1.374% as a wise move for anyone.


Maybe APLerner can explain himself to Mr. Wenzel.

Edward said...

"Furthermore, Austrians, unlike Keynesians, who believe that factors of production generally are homogeneous and are equally affected by new injections of spending, look carefully at the issues of the factors, for what is where the result of the downturn are concentrated"

Professor Anderson, Let me begin by saying that I have little sympathy for Paul Krugman. I'm from Chicago, both intellectually and physically. i'm also a passionate believer in the free market. But just as Milton Friedman disagreed with Hayek on the the ATBC, so must I, (as much as I hate defending Krugman) actually defend Krugman in this case.
You talk about malinvested resources. What is MALinvestment but a formm of overinvestment? Even investment garbage has SOME value (Say a 100,000 dollar mortgage backed security during the bubble worth 1000 dollars in actual cash flow)
And you COMPLETELY miss the point of Krugman's post. Just as Krugman wrongly accuses the Austrians of being economic sadists who want to perpetuate mass unemployment... You miss his emphasis on the fact that EVERY INDUSTRY SUFFERS! NOT just the bubble industry"
"Instead, Austrians hold that those investments in capital and other factors that no longer are sustainable should be liquidated or transferred to other uses for which there clearly is consumer demand"
But there IS NO CONSUMER DEMAND! EVERY SECTOR suffered. For Christ sake, Germany didnt have a housing bubble, and its exports plunged during the recession.
And if you want to talk about deflation, fine. I happen to agree that deflation (Combined with debt relief of course, or else it would be a disaster for debtors) in every sector would help (yes there's that term) aggregate demand And by the way, I doubt even Krugman would agree, that computers, cars and homes amount to the same thing. But for the purposes of this depression, where every industry suffers, there are commonalities in every heterogenous capital structure and every industry, therefore, it is no real problem to talk of aggregate demand.
And Bob Roddis, a balance sheet recession, means EVERYONE (not just one industry) took on too much debt during the bubble. I happen to agree that the Fed kept interest rates too low. But no one forced debtors to accept such loans.
And AP. I dont believe the US government represents a solvency or a credit risk. I do believe that it represents an inflation risk, but that is a different story Either we will inflate or we won't. Either case,if inflation, buying government bonds will be a losing proposition, if not, yields are so pathetically low that it would be ridiculous to buy government bonds anyway

AP Lerner said...

Back in June, your hero Wenzel said this in regards to China selling treasuries

"The long term consequences will certainly be negative."

since then, China has massively sold treasuries. I'll let you google and sea what rates have done during that time period. This is about all I need to know about Wenzel, and chalk him to someone as equally clueless about the monetary system as you and Prof. Anderson.

And PS - yes, I am ignoring your other comments because 1) I have addressed everyone of your comments before in the past and all you do is respond by copying and pasting something you get from mises.org or lewrockewell.com (kind of like you just did with Wenzel - do you get paid for being a spokesperson for mises.org?) and 2) your comment on the housing market is so off the mark and based off nonsense, it actually pains me to think of responding. Here is something from someone who actually understands the housing market:

http://www.google.com/reader/view/user/05319178760619763959/label/street-blahs#stream/user%2F05319178760619763959%2Fstate%2Fcom.google%2Fstarred

Click through his other posts for a complete education based off data and facts, not this ideological driven rubbish Prof. Anderson preaches.

AP Lerner said...

and this is what a balance sheet recession looks like. I know, I know...Austrians don't look at data and don't believe in empircal evidence. But some folks do.

http://www.ritholtz.com/blog/wp-content/uploads/2010/08/Total-Debt-Balance-and-its-Composition.png

Bob Roddis said...

And PS - yes, I am ignoring your other comments because

like all other Austrian "critics", you haven't responded because you can't and thus you won't.

Where are the human beings in your strange imaginary world, APLerner?

I was taught in school to give citations for my sources. I would think that someone as oblivious as you are about Austrian theory would prefer to learn it from original source material as opposed to my little comments.

Regarding "overinvestment", the gist of the theory is, I suppose, overinvestment in the wrong lines of production which was induced by impaired economic calculation as the result of the funny money regime of theft and fraud. That's not the same as a mere generalized theory of "overinvestment". Krugman is a liar and fraud.

Bob Roddis said...

Steven Horwitz takes down Krugman (HT2 Bob Murphy):

It's a model with no price level, no time, and no capital. It's the worst of Keynesianism in one picture.

But it is all nice and simple this way and anyone who disagrees with Krugman is making it up as they go along to satisfy some irrational prejudice.

No Paul, not really. The basic Austrian model has been around for close to 100 years (if we go back to Mises in 1912) and it's done fairly well in explaining why things go wrong, including the current boom and bust. That's not ad hocery, nor is it a prejudice. It's the consistent application of a theory that's been around longer than yours.

If you disagree Paul, lay out your objections, but to argue critics of further monetary expansion have no theory and are just justifying a prejudice is to reveal your own ignorance of alternative perspectives and continue in your typical ad hominem style.

Frankly, with the failure of the stimulus, it seems like if there's ad hocery anywhere it's in Krugman's corner of the world.

If you were skeptical that the Austrian view of capital is central to the differences between how Austrians view the macroeconomy and how many other economists do, Krugman gives you some evidence to consider.


So who uses data and who doesn't? Austrians look to detailed explanations of the heterogeneity of the capital structure. Chartalists and Keynesians just see an ice cream scoop glop of "investment".

Anonymous said...

Creating caricatures of Keynesian economics and repeating the same strawman over and over again is the only thing you do in this blog. This is hilarious.

Bob Roddis said...

Keynes creates his very own caricature:

Keynes states that it would be better if the central bank would simply just dilute the money supply so that there might be UNIFORM wage reductions to cure unemployment:

(i) Except in a socialised community where wage-policy is settled by decree, there is no means of securing uniform wage reductions for every class of labour. The result can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expedience, and probably completed only after wasteful and disastrous struggles, [when did this happen????] where those in the weakest bargaining position will suffer relatively to the rest. A change in the quantity of money, on the other hand, is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable…….

(ii)…..If important classes are to have their remuneration fixed in terms of money in any case, social justice and social expediency are best served if the remunerations of all factors are somewhat inflexible in terms of money. Having regard to the large groups of incomes which are comparatively inflexible in terms of money, it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter.

(iii) The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage-unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former.
“The General Theory” Pages 268-269

Anonymous said...

Bob, that's something that even your great leader, Frederick Von Hayek, suggested to do in certain situations.

" Hayek now says there are two exceptions to the rule that changes in aggregate demand do not affect the level of employment. The first one was “an accidental historic situation.” In 1925 Britain made the mistake of returning to the gold standard at the prewar parity, which meant that real wages were too high. “In this situation,” he wrote, “the restoration of employment required a reduction of real wages which could he achieved by a general rise of prices” "
http://www.cato.org/pubs/journal/cj6n2/cj6n2-4.pdf

In fact, that's the exact same thing (high wages) Krugman has been saying is the main problem in some of the countries in the eurozone (Spain, Greece). God, Hayek was such a moron, right?

Troy Camplin said...

It does not surprise me that Krugman misrepresents the Austrian position, as misprepresentation is all he ever does in his NYT pieces. He has to, because the facts and data are not on his side, and he has a theory made up of dragons and fairies. Having read Krugman before he joined the NYT -- I think especially of his "The Self-Organizing Economy" -- I know that Krugman actually knows better. What does it say about a man who knows the truth, and then purposefully misrepresents it for political purposes? There's a term for those who know what the good is and choose against it.

Keynesianism as a whole is one of the most ridiculous sets of ideas on economics I have ever read. I don't understand how anybody with any sense -- or who doesn't want to use it to centralize political power -- can support Keynesianism. That doesn't mean there isn't one or two things worth recovering from the large pile of b.s., of course, but for the most part, Keynesianism b.s. has mostly produced nothing but shrooms -- and the users think the hallucinations are reality.

Anonymous said...

Edward,

Every business - and individual - also benefited from the largess of the boom. But they did not benefit equally, and it is absurd of you to claim that they are now suffering equally. There is no comparison between the fate of Toll Brothers and that of Walmart or Intel. You say that consumer demand has fallen equally in every industry... I cannot imagine how you could be more categorically wrong.

Balance sheets are never a problem until asset values fall. This is not a "balance sheet" recession but the result of a crash in property values and, subsequently, a heavily compromised banking system. THERE are your malinvestments, and it is precisely there that your wealth is being redirected: into the hands of irresponsible borrowers and equally irresponsible lenders. Our every resource is being devoted to the preservation of bad debts and speculative enterprises.

They are a drain upon the productive economy, and it is because we have prevented their liquidation that demand will continue to languish. Stimulus will do nothing to address the problem; increased demand will be short-lived, and the wasted capital will only add to the task of rebuilding that lies ahead of us. This is why Krugman is wrong... and it is why Keynes gave us the great depression.

Bob Roddis said...

“In this situation,” he [Hayek] wrote, “the restoration of employment required a reduction of real wages which could be achieved by a general rise of prices”

Having personally recorded Hayek on “Firing Line” in 1977, the issue comes down to how obtain the re-pricing made necessary by prior monetary foolishness. I say do nothing and allow the re-pricing to begin. Or if there are legal impediments to the re-pricing, remove them.

Keynes is saying that the MAGIC STATE must dilute the currency and trick the workers by stealth into accepting lower wages (as if they wouldn’t catch on to this ruse quickly). I am on record as saying that “The General Theory” was an ad hoc theory designed to induce a policy in Great Britain in the 1930s of inflation in order to trick workers into accepting lower wages because openly forcing lower wages upon them was otherwise politically impossible.

Anonymous said...

"Keynes is saying that the MAGIC STATE must dilute the currency and trick the workers by stealth into accepting lower wages"

Guess what? Hayek agrees with him. What a complete moron Hayek was, right? right? Obviously, everything Hayek has ever said should be disregarded because he was a complete loon.

And it gets worst. Hayek continues on to say.
--

“The second situation in which it is true that an increase of employment requires an increase in aggregate demand,” Hayek (1974, p. 5) now maintains, “is found in the later stages of a depression when, in consequence of the appearance of extensive unemployment, the economy frequently is subjected to a cumulative process of contraction of secondary deflation, which may go on for a very long time.” He concludes:

"I am the last to deny – or rather, I am today the last to deny – that, in these circumstances, monetary counteractions, deliberate attempts to maintain the money stream, are appropriate. I probably ought to add a word of explanation: I have to admit that I took a different attitude forty years ago, at the beginning of the Great Depression. At that time I believed that a process of deflation of some short duration might break the rigidity of wages which I thought was incompatible with a functioning economy. Perhaps I should have even then understood that this possibility no longer existed. … I would no longer maintain, as I did in the early ‘30s, that for this reason, and for this reason only, a short period of deflation might be desirable. Today I believe that deflation has no recognizable function whatever, and that there is no justification for supporting or permitting a process of deflation."

--

WHAAAATTTT? He also favors further diluting the money supply to stop deflation? This situation he describes sound awfully familiar. Oh right, we're in it now.


"I am on record as saying that “The General Theory” was an ad hoc theory designed to induce a policy in Great Britain in the 1930s"

If you have been listening to modern Keynesian, you would know that to a certain extent they would agree with you, except it would apply to more countries than just Great Britain. Keyne's book was meant to address depressions in extremely specific circumstances. And we're in very familiar ground today which is why his book is relevant again.

But heck, Krugman's monetary views aren't even based of Keynes. They're based on Miltonn Friedman.

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