Monday, June 20, 2011

Princeton University Economics: there is no such thing as opportunity cost

Because I am a holder of a doctorate from a program that was not "elite" by any standards, perhaps I don't understand the power that "elite" economists have in their possession to do away with economic laws. While Paul Krugman is on vacation, his Princeton colleague, Alan Blinder, gives us the latest howlers.

Writing in the Wall Street Journal, Blinder wonders how anyone might think that lots and lots of federal spending would be "job killing." Impossible! Blinder huffs:
It is easy, but irrelevant, to understand how someone might object to any particular item in the federal budget—whether it is the war in Afghanistan, ethanol subsidies, Social Security benefits, or building bridges to nowhere. But even building bridges to nowhere would create jobs, not destroy them, as the congressman from nowhere knows. To be sure, that is not a valid argument for building them. Dumb public spending deserves to be rejected—but not because it kills jobs.

The generic conservative view that government is "too big" in some abstract sense leads to a strong predisposition against spending. OK. But the question remains: How can the government destroy jobs by either hiring people directly or buying things from private companies? For example, how is it that public purchases of computers destroy jobs but private purchases of computers create them?

One possible answer is that the taxes necessary to pay for the government spending destroy more jobs than the spending creates. That's a logical possibility, although it would require extremely inept choices of how to spend the money and how to raise the revenue. But tax-financed spending is not what's at issue today. The current debate is about deficit spending: raising spending without raising taxes.

For example, the large fiscal stimulus enacted in 2009 was not "paid for." Yet it has been claimed that it created essentially no jobs. Really? With spending under the Recovery Act exceeding $600 billion (and tax cuts exceeding $200 billion), that would be quite a trick. How in the world could all that spending, accompanied by tax cuts, fail to raise employment? In fact, according to Congressional Budget Office estimates, the stimulus's effect on employment in 2010 was at least 1.3 million net new jobs, and perhaps as many as 3.3 million.
This is a most interesting economic worldview. While Blinder might be "technically" correct in that if government borrows a trillion dollars and spends it on whatever, then in the very short term, no doubt there would be new employment. Would it create new wealth? That is another matter, and would it be sustainable? probably not.

Yet, Blinder really doubles back on himself in that first paragraph. Let me repeat what he said:
But even building bridges to nowhere would create jobs, not destroy them, as the congressman from nowhere knows. To be sure, that is not a valid argument for building them. Dumb public spending deserves to be rejected—but not because it kills jobs.
What would constitute "dumb public spending," given that he believes that government spending "creates jobs," even "dumb" spending. What is the criteria for determining that the spending is "dumb," and why would it matter, anyway?

No doubt, Blinder would employ an opportunity cost argument but then he contradicts that argument not only within his sentence, but also further down in the article. He states:
A second job-destroying mechanism operates through higher interest rates. When the government borrows to finance spending, that pushes interest rates up, which dissuades some businesses from investing. Thus falling private investment destroys jobs just as rising government spending is creating them.

There are times when this "crowding-out" argument is relevant. But not today. The Federal Reserve has been holding interest rates at ultra-low levels for several years, and will continue to do so. If interest rates don't rise, you don't get crowding out. (emphasis mine)
So, all that is needed to eliminate "crowding out" (which also is opportunity cost in action) is for the Fed to hold down interest rates by mere fiat? (Oh, I forgot. Ben Bernanke was the chair of the economics department at Princeton before going to the Fed, and he still is listed as being on the faculty there. If one is a Princeton economist, a mere declaration can eliminate that pesky thing called opportunity cost.)

Is all of this spending "job killing"? If one goes by Blinder's ultra-short term view of spending and "job creation," then it is not "killing" jobs. However, if one sees this spending along with other government efforts to prop up the economy as impeding the liquidation of malinvestments and impeding a real recovery, then by all means the government spending spree is killing jobs by the millions.

41 comments:

Mike M said...

Blinder dismisses the “crowding out” arguments by stating: “The Federal Reserve has been holding interest rates at ultra-low levels for several years, and will continue to do so. If interest rates don't rise, you don't get crowding out.”
At what cost??? Blinder is tone deaf to consequential costs of interventionist actions. Seriously, do you have to be an economic illiterate to serve on the FRB?

Major_Freedom said...

However, if one sees this spending along with other government efforts to prop up the economy as impeding the liquidation of malinvestments and impeding a real recovery, then by all means the government spending spree is killing jobs by the millions.

Excellent point.

Arguing "We can cure hangovers by remaining drunk!" is not a real solution to the problem.

Salamano said...

Let's see... "800 Billion" in stimulus, creating a net of "1.3 million" jobs

Thats... $6,153,846.15 spent per job created. Private industry would be so jealous to have such an amazing return on their investment (sarcasm).

Furthermore, if the federal stimulus just went to state/local governments to stave off public sector staff reductions for one more year, then what does that solve.

Paul Krugman recently posted: "A fiscal response to a severe slump doesn’t require committing yourself to changes once the storm has passed; it “only requires unusual action while the situation remains grave.”

If the stimulus is enlarging the structure, how are we not committing ourselves to (fiscally debilitating) changes? As has been said, "never let a good crisis go to waste".

Anonymous said...

One thing I've noticed in all of your arguments against Krugman, is that you never cite any data to support your claims, something he does daily. Basically you're making a philosophical argument from unproven first principles, whereas he actually uses empirical evidence to back up his assertions.

Anonymous said...

Salamano, I think you misplaced the decimal point--it's actually about $615k per job (allegedly) created. Still not a very good rate of return, of course.

Anonymous said...

Actually, that is $615,384 per job created. And if you also consider jobs saved, that brings the total to ~3 million and that brings it to $266,666 per job.

This does not include the spillover effects of people having jobs, not losing their homes, and new infrastructure on the rest of the economy.

Or think of the stimulus as spending $2,666 on each American and compare that to the amount of wealth lost by each American in the recession and that would have been lost with no intervention.

American Patriot said...

Krugman, LK, Will, Anomymous, and other collectivists make assertions and claim that federal/government spending crowding out private investment is a non-supported assertion by the other side.

For the nth time:
http://hotair.com/archives/2010/05/27/study-finds-increased-govt-spending-results-in-unemployment/

And the study:

http://www.people.hbs.edu/cmalloy/pdffiles/envaloy.pdf

You guys are all morons if you need to be told the evidence a zillion times and you still claim no proof is shown.

Mike M said...

Anonymous: Spare me please!!! If your premise is flawed then everything then emanates from that premises are flawed. Krugman and his acolytes operate from a flawed premise that is primarily designed to rationalize and legitimize government incursion in people’s lives at the expense of their liberty.
Shallow minds surround themselves with endless data and citations. Check and validate your premise first then you can explore the world of data.

Bob Roddis said...

Things can't be in two places at the same time except in the alternative bizarro world of the Keynesians.

http://www.flickr.com/photos/bob_roddis/4163003939/in/set-72157600951970959

Anonymous said...

Mike M - facts are facts. Regardless of premises. Funny though how "Austrian" premises and assumptions never seem to pan out in the real world. Could it be the assumptions that are wrong?

William L. Anderson said...

Please give an example. The Austrians not only were speaking out against the stock bubble, but also were early in predicting disaster with the housing bubble. A number of us including Mark Thornton, Bob Murphy, and me were writing stuff on these subjects long before they went mainstream.

But, I doubt you are interested in that, given you already have declared all of Austrian Economics to be false.

Mike M said...

Anonymous I will try this one more time (why I bother I don’t know)

Facts are facts. Gee, what divine insight that is.

Facts are meaningless without context and an understand of “why”

It’s 80 degrees outside, that is a fact. So what. It offers nothing of value by itself.

Why is it 80 degrees?
Is that seasonal or not given the location?
What’s the humidity?
Sunny or not?
Windy or not?
Is it likely to stay 80 degrees?
For what period of time?
Does that affect your plans?
ETC . ETC.

Every day we take in data and synthesize it, consciously and unconsciously to make it relevant to ourselves then we act accordingly. An economy works the same way. Millions of micros making up the macro. Neo-Keynesians believe the economy is a science lab experiment. Accordingly all that is necessary is read the data in an academic manner and change the ingredients or push different buttons without understanding the human behavior is the dog not the tail.

Your statement: “ Funny though how "Austrian" premises and assumptions never seem to pan out in the real world.”

Are you blind? They are playing out in front of you right now. Open your eyes and look. Take off the statist lens you have been shackled with since school and see it for what it really is.

Tom said...

"Dumb spending" is spending you approve of. Non-"dumb spending" is spending he approves of.

Bala said...

Mike M,

These people are so hopelessly dependent on the system that they will die to defend it.

ekeyra said...

Anon

"Or think of the stimulus as spending $2,666 on each American and compare that to the amount of wealth lost by each American in the recession and that would have been lost with no intervention. "

Your conclusions have nothing to do with anything preceeding them. If americans spent $2,666 to give someone else a job how is that helping them considering thats a cost alongside any losses from the recession? Also how can you bring what would have happened with no intervention into your analysis without visiting an entirely different universe where it didnt happen? If you are using the models they trotted out to show the stimulus would stem job losses and keep unemployment below 9 percent, wouldnt that tell you which models "panned out in the real world"?

Mike M said...

Bala, How true that is!

Anonymous said...

I predict it will rain...eventually.

Now you also had Nouriel Roubini with a very precise prediction and Raghuram Rajan wrote an important paper about the risks of international banking. So maybe predicting the housing bubble is not the best evaluative standard.

I am still waiting for the massive wave of inflation, run on US treasuries

Mike - your criticism of an empirical approach to economics is valid. But, it is not Austrian. You are simply elaborating on the neo-classical critique of macro-economics and focus more heavily on methodological individualism. I tend to believe that there are a lot of problems with regard to methodological individualism - how to aggregate them into what are eventually social actions, the basis of human behavior (strict material rationality) and the cognitive limits of the human mind. Austrians similarly share many of these assumptions (although they name them something differently) but refuse to acknowledge and social science rooted in the real world. They make "logical" statements that will never correspond to how people actually behave under certain conditions.

The point about facts is that first your math was wrong and second that it might change how you think about the actual cost and impact of the stimulus package. To spend $2,600 through borrowing in order to prevent a downfall seems more reasonable than just stating the $800 billion figure.

And on that - a large amount of the $800 billion were tax cuts, so not really taking money out of people's pockets. The rest is taking future money out of someone's pocket.

Assessing the impact of stimulus vs. no stimulus is difficult - and you can't tell me with 100% certainty that the absence of a stimulus would have made things better. There is no lab for this but we have comparative knowledge from Japan. We can trace how stimulus money actually created jobs or changed people's economic behavior. And yes, we have models that approximate how certain factors will impact economic behavior, given certain assumptions and parameters. Imperfect yes, but inaction out of fear that we can never truly know what motivates people is simply inadequate.

Lord Keynes said...

The Austrians not only were speaking out against the stock bubble, but also were early in predicting disaster with the housing bubble. A number of us including Mark Thornton, Bob Murphy, and me were writing stuff on these subjects long before they went mainstream

For god's sake, even the Marxists correctly calling the housing bubble:

Marxists in 2004:

"“the lowest home mortgage rates in decades were a major contributor to record sales of existing residences, engendering a large extraction of cash from home equity.” That cash was used to support personal consumption spending, home improvement, and the repayment of higher cost debt. In other words, far from indicating a healthy economy, the increase in consumption spending was largely the result of the housing bubble created by the Fed’s low-interest rate regime."

http://www.wsws.org/articles/2004/feb2004/gpan-f16.shtml

2004:
http://www.wsws.org/articles/2004/sep2004/hous-s27.shtml

2005:
http://www.wsws.org/articles/2005/aug2005/hous-a06.shtml

2007:
http://www.wsws.org/articles/2007/sep2007/econ-s03.shtml

You and Murphy are as about "right" as Marxists like Paul Sweezy and Paul Baran *predicted* the 2008 crisis:

http://socialistworker.org/2009/04/13/marxism-and-the-financial-crash

And when I say that: I mean both you and the Marxists have theories that are fundamentally flawed, even though you identifed the bubble.

The Marxists have their absurd historical materialism, the belief that the rate of profit will always fall, the erroneous labour theory of value, and the idea that socialism is inevitable, while you have a system flawed by a fantasy business cycle theory, an incoherent and logically inconsistent demand for no fractional reserve banking, and insufficient attention to subjective expectations and the role of investment decision-making under uncertainty.

To their credit, the Lachmann-wing does take some of the later concepts seriously and concludes: they is no automatic tendency for short run return to plan/pattern coordination or neoclassical general equilibrium in free markets.

Lachmann, L. M. 1976. “From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society,” Journal of Economic Literature 14.1: 54-62.

Lord Keynes said...

Also, the Post Keynesian Dean Baker predicted a housing bubble in August 2002 before it began:

http://www.cepr.net/index.php/publications/reports/the-run-up-in-home-prices-is-it-real-or-is-it-another-bubble

Also, the low interest rates that led to sub-prime did not cause Austrian trade cycle effects, such as overinvetsment in higher-order capital goods.

Austrians use a ridiculous theory that posits that the credit flows to producers, not to consumers, to produce the cycle effects.

In 2001-2008, you had consumer loans to people who shouldn't have got them. The asset bubble in housing and the defaults and the collapse in value of the mortgage-backed securities caused a systemic financial crisis, precisely as predicted by Hyman Minsky's financial instability hypothesis.

The debt deflationarty effects and credit crisis, financial instability flow into collapse of consumption and investment, exactly explicable as a failure of aggregate demand.

Bala said...

"precisely as predicted by Hyman Minsky's financial instability hypothesis"

That hypothesis is the most absurdly stupid thing ever proposed. It is meant for idiots who cannot understand that instability is brought upon financial markets by...... Guess who!

No prizes for guessing, of course.

Bala said...

"while you have a system flawed by a fantasy business cycle theory,"

What you say on that cess-pool that you call your blog is not the final word in Economics.

Mike M said...

LK so you believe "demand" drives the economic bus? That it's the lack of "demand" causing the current economic malaise?

American Patriot said...

"LK so you believe "demand" drives the economic bus? That it's the lack of "demand" causing the current economic malaise?"

As they think ass-backwards, he does.
It takes some trace of common sense to comprehend that consumer psychology is most affected by the employment picture and until businesses invest and create jobs, consumers will not spend regardless of how much credit they have.

João Marcus said...

LK so you believe "demand" drives the economic bus? That it's the lack of "demand" causing the current economic malaise?

That's all a Keynesian knows when it comes to crisis such as the current ones. They study economics for decades, they know a lot of absurdly complicated formulas, but they are unable to really solve any real problems, they create even worse ones, but hey, at least they can kick the can and say they "saved US from a Great Depression". When their free money starts fading, well, it's time to spend even more! They can't get past their aggregate world. They think the world is a bunch of big, fat aggregates. That's all there is to it.

Bob Roddis said...

Even the concept of "aggregate demand" is absurd. What is wrong with using everyday language to note that in a recession, people will find themselves poorer than they had previously been misled to believe during the boom? Further, their relative poverty is not an explanation per se of the cause of such poverty. Wow. People are too poor in a recession to buy what they bought during the boom. Who knew?

The term "aggregate demand" is used to confuse the weak-minded and to suggest that aggregated cases of individual poverty are an identifiable collectivist unitary "thing". And that this "thing" can be increased by money dilution and the donut eaters blowing tons of money on debt in order to buy votes. Sure.

jason h said...

Also, the low interest rates that led to sub-prime did not cause Austrian trade cycle effects, such as overinvetsment in higher-order capital goods.

Please define a higher-order capital good.

Is it a shoe factory building Crocs because money printing created the illusion of wealthy consumers, is it a Chrysler factory, a cupcake shop?

If what you said is correct, then the housing bubble could have popped and the rest of the economy would be unaffected.

Bob Roddis said...

LK finds that he must split hairs when it comes to the issue of higher-order capital goods. Because he cannot fathom the concept of economic calculation, he does not understand that money dilution will naturally impair long term and complex calculation more than short term and less complex calculation.

Thus, he can argue with a straight face that housing is not a higher-order capital good because it's a durable consumer good and thus, the Austrians cannot explain the housing boom. He really says this.

Further, why was everyone in such a hurry to buy housing? Because everyone was looking for an inflation hedge. And who/what causes inflation?

Bob Roddis said...

Just to be clear, I am well aware of the differences between a "higher order capital good" and a "durable consumer good". But they are similarly susceptible to problems of economic calculation because the production and financing required for them occur over longer periods of time.

Lord Keynes said...

"Even the concept of "aggregate demand" is absurd

If there is no "aggregate demand", then there is no Say's law:

http://socialdemocracy21stcentury.blogspot.com/2011/05/says-law-presupposes-aggregate-demand.html

Lord Keynes said...

"Because he cannot fathom the concept of economic calculation, he does not understand that money dilution will naturally impair long term and complex calculation more than short term and less complex calculation."

You've just had a lesson on why ABCT is B.S.

(1) ABCT assumes a single real natural rate that does not exist in a growing, money-using economy, as Sraffa showed (1932a and 1932b).

(2) Money can never be made neutral, as Hayek wanted, and a state in which money is neutral is nothing but a state in which money does not exist:

“The starting-point and the object of Dr. Hayek’s inquiry is what he calls ‘neutral money’; that is to say, a kind of money which leaves production and the relative prices of goods, including the rate of interest, ‘undisturbed,’ exactly as they would be if there were no money at all. This method of approach might have something to recommend it, provided it were constantly kept in mind that a state of things in which money is ‘neutral’ is identical with a state in which there is no money at all: as Dr. Hayek once says, if we ‘eliminate all monetary influences on production ... we may treat money as non-existent’” [Prices and Production, p. 109]. .... (Sraffa 1932a: 42).

(3) Wicksellian monetary equilibrium assumes an economy running at full employment: but in reality capitalist systems have historically had many periods when they are mired in underemployment disequilibria, or movements from one underemployment equilibrium to another, where there are significant idle resources, like labour, raw materials, capital goods and other factor inputs. If an economy with significant idle resources has investment via fractional reserve banking or central bank creation of excess reserves (without prior saving in loanable funds), how will the inflationary pressures imagined by ABCT happen if productive resources simply do not need to be freed in the stages close to consumption? Such factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries, or even imported from overseas.

(4) The natural rate is conceived as an equilibrium interest rate that equilibrates loanable funds supply with demand for credit.

This idea that an increase in saving due to a fall in consumption would not decrease aggregate demand because there is a corresponding increase in investment in capital goods to compensate for the fall in consumption is an assumption underlying Say’s law, from which it is concluded that aggregate demand will remain the same and only its composition will alter. But subjective expectations in the investment decision destroy any such consistent, reliable automatic process to create the necessary investment.

Bob Roddis said...

How can anyone seriously deny that the total demand for final goods and services in an economy is not a fundamental and meaningful concept here?

To the extent that such an analysis helps us understand the general wealth of a society, it is probably a helpful measure. But the totality is nothing more than the adding up of individual transactions. It is not as though hydrogen and oxygen have been combined to create an entirely new substance. It remains nothing more that a listing and summation of the prices used in a multiplicity of individual transactions and exchanges.

Further, the concept does not help answer the question of why people are generally wealthy or poor in a particular or general circumstance and it certainly does not suggest that people need to be artificially induced to spend newly created funny money to induce the creation of new wealth or that such a regime could possibly work as planned.

The problem of general poverty is the problem. Calling it a "lack of aggregate demand" is intended merely to mislead the weak-minded about the causes of and solutions to the problem.

MethodMan said...

The only response that Keynesians need to Austrians who criticize them with meaningless drivel is the following:

"We were correct about inflation, we were correct about interest rates...you have been consistently wrong on just about everything since the 08 crisis. Peace."

Lord Keynes said...

"To the extent that such an analysis helps us understand the general wealth of a society, it is probably a helpful measure."

LOL...
Helpful measure? A helpful measure can only be one that is meaningful and valid: no concept that is lacking meaning or that is invalid can be a "helpful measure."

This quite an admission. I'll remember the next time I hear some rubbish here about aggregate demand not being a meaningful concept.

João Marcus said...


Helpful measure? A helpful measure can only be one that is meaningful and valid: no concept that is lacking meaning or that is invalid can be a "helpful measure."


"Aggregate demand" is not really meaningful when it's used as a base for economic analysis, as if we could treat the world as a bunch of numbers that economists can manipulate to lead us to prosperity. So, aggregate demand may have a meaning, but it's impossible to measure and generate reliable numbers. That's why Keynesians may have "predicted" the current crisis, but they have also said government spending would fix everything.

Bob Roddis said...

I should have been more clear that I have real problems with the components of AG as a "helpful measure" of wealth. Naturally, LK ignored the gist of my comment which was that "AG" isn't a "thing" and the fact that people realize that they are poorer after the end of a boom than they thought during the boom does not prove the cause of or the cure for the bust.

Bob Roddis said...

The only response that Keynesians need to Austrians who criticize them with meaningless drivel is the following:

"We were correct about inflation, we were correct about interest rates...you have been consistently wrong on just about everything since the 08 crisis. Peace."


Except that Keynesian policies have brought us to our economic knees and Austrians have been generally right about the entire scenario since 2005.

And my own predictions have been pretty good. I never believed the forecasts of imminent hyperinflation in the 80s. I figured in 2004 that there was a housing bubble caused by funny money that would collapse into a Great Recession. When it collapsed, I thought that there would be a period of deflation as assets were re-priced and which would disguise the underlying general price inflation caused by new funny money dilution. In fact, I thought that there would be a bit more general deflation than there has been. The inflation that is now occurring was also predicted for a few years down the road back in 2008.

I also assumed and predicted that super low interest rates would be catastrophic and would seriously preclude a recovery because higher rates would be closer to the underlying natural rate. Many Austrians at the time said the same thing.

http://mises.org/daily/3327

I still think we face potential hyperinflation in the future based solely upon the amount of government debt and unfunded liabilities for the reason that government is not revenue constrained but it certainly is “stuff constrained”.

Further, I’m through defending alleged mistakes that LK digs up of Hayek or Mises from 80 years ago. There can be only one “natural rate” and if Hayek agreed there were more, he was mistaken or simply was not focused upon the subject matter. Seeing that those guys were so brilliant on so many topics for so long being virtually solitary forces for good in a vast sea of Keynesian, socialist and fascist evil, they are allowed a mistake here and there.

And LK still does not understand the concept of “economic calculation”.

Bala said...

LK,

"You've just had a lesson on why ABCT is B.S."

And you've just had a lesson on why you and all the heroes you worship are full of B.S.

I have spent enough time demonstrating why your criticisms of ABCT are utter hogwash.

Major_Freedom said...

Lord Keynes:

(1) ABCT assumes a single real natural rate that does not exist in a growing, money-using economy, as Sraffa showed (1932a and 1932b).

No, ABCT does not assume a single natural interest rate. The natural interest rate refers to each instance of saving and investment, which means many different interest rates can co-exist.

(2) Money can never be made neutral, as Hayek wanted, and a state in which money is neutral is nothing but a state in which money does not exist

The ABCT presupposes a non-neutral money. Inflation into the loan market has real effects on the capital structure of the economy.

(3) Wicksellian monetary equilibrium assumes an economy running at full employment: but in reality capitalist systems have historically had many periods when they are mired in underemployment disequilibria, or movements from one underemployment equilibrium to another, where there are significant idle resources, like labour, raw materials, capital goods and other factor inputs. If an economy with significant idle resources has investment via fractional reserve banking or central bank creation of excess reserves (without prior saving in loanable funds), how will the inflationary pressures imagined by ABCT happen if productive resources simply do not need to be freed in the stages close to consumption? Such factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries, or even imported from overseas.

No, ABCT does not require full employment either. See Bob Murphy's article that refutes "idle resources."

(4) The natural rate is conceived as an equilibrium interest rate that equilibrates loanable funds supply with demand for credit.

It does not presuppose a single interest rate in the real world economy.

This idea that an increase in saving due to a fall in consumption would not decrease aggregate demand because there is a corresponding increase in investment in capital goods to compensate for the fall in consumption is an assumption underlying Say’s law, from which it is concluded that aggregate demand will remain the same and only its composition will alter. But subjective expectations in the investment decision destroy any such consistent, reliable automatic process to create the necessary investment.

If there is an increase in cash preference, then you cannot claim that it can only come from consumption. You Keynesian yahoos have this fallacious notion that the order people take when they make decisions is consume or not consume, then save or not save cash, then decide how much to invest or not invest. That is not how people decide. They make these decisions concurrently. If people hold more cash, and their time preference does not change, then they will reduce both investment spending and consumer spending, leaving the original ration unchanged.

If they reduce their consumption spending and increase their cash balances, then as Jesus De Soto shows, this generates a lengthening of the structure of production even if there is no concurrent addition to investment on account of reduced consumption.

Aggregate demand will fall if cash preference goes up. One cannot claim that investment cannot rise if one consumes less. People can do that. If consumer spending falls, but investment does not rise, then that will generate a changed RELATIVE PRICE STRUCTURE, which you Keynesians can't see because you're so fixated on aggregate demand all the damn time. A changed relative price structure will put into motion a redirection of resources and labor to where there is relatively more profitability, DESPITE aggregate demand falling.

If the government does not interfere in prices, through either labor market regulation or price controls, or inflation, then prices can indeed fall, costs included.

Major_Freedom said...

Lord Keynes:

Also, the Post Keynesian Dean Baker predicted a housing bubble in August 2002 before it began:

http://www.cepr.net/index.php/publications/reports/the-run-up-in-home-prices-is-it-real-or-is-it-another-bubble

Dean Baker later REVISED his prediction because he realized it was false.

"Despite the fact he foresaw the crisis before anyone else and warned about it, if you followed his predictions you could have lost or made money depending on the time you listened to him. Whether you made money or lost money by or selling your house it depends on the time you listened to his advice. If you sold your house in 2002, 2003, or 2004 you would have lose money. If you listened to him in 2005 you would have saved yourself a lot of money. Dean Bakers went quiet on the topic in 2006 and 2007. The problem with Dean's prediction is timing, while other economists who predicted the crisis warned about it in 2006 & 2007."

http://www.economicpredictions.org/dean-baker-predictions/index.htm

Also, the low interest rates that led to sub-prime did not cause Austrian trade cycle effects, such as overinvetsment in higher-order capital goods.

Yes, it did. Durable consumer goods like houses are affected the same way higher order capital goods are affected.

Austrians use a ridiculous theory that posits that the credit flows to producers, not to consumers, to produce the cycle effects.

To the extent it went to housing, when the economy was not productive enough to warrant such a massive redirection of scarce resources, that is textbook ABCT.

In 2001-2008, you had consumer loans to people who shouldn't have got them. The asset bubble in housing and the defaults and the collapse in value of the mortgage-backed securities caused a systemic financial crisis, precisely as predicted by Hyman Minsky's financial instability hypothesis.

Minsky's instability hypothesis is an ex post facto explanation for the collapse. It cannot predict a bubble or collapse.

Minsky's instability hypothesis cannot predict a bubble, because we cannot identify the motivation for why an individual takes on debt, and we must wait until AFTER THE FACT. His theory hinges on an implied ability to know when a borrower borrows for hedge reasons, for speculative reasons, or for ponzi reasons. Minsky's theory became popular only after the bubble burst, because it provides a seemingly plausible explanation for what already happened.

It cannot be used to PREDICT a bubble will happen.

The debt deflationarty effects and credit crisis, financial instability flow into collapse of consumption and investment, exactly explicable as a failure of aggregate demand.

This does not explain why there is deflation. It merely takes it for granted. ABCT can explain it.

Bala said...

"If they reduce their consumption spending and increase their cash balances, then as Jesus De Soto shows, this generates a lengthening of the structure of production even if there is no concurrent addition to investment on account of reduced consumption."

Great point. Once you mention it, it looks so obvious. I would like to go through the entire explanation from de Soto. Could you give the source (with links if possible) please?

burkll13 said...

Bravo, Major. Bravo.