Tuesday, October 4, 2011

Do economic conditions make opportunity cost disappear?

With the flavor-of-the-week being blaming China for the economic depression this country caused, Paul Krugman is at it again. At least the theme is constant: a "liquidity trap" changes all the "rules" of economics.

This is a nice way of saying that if Paul Krugman believes the economy is in that "liquidity trap," then he gets to say what the "new rules" of economics are, and the first thing to go is that oppressive Law of Opportunity Cost. He writes:
Now, some people will ask, didn’t I used to be a free-trader? Yes, and under normal circumstances I still mostly am. But these are not normal circumstances! In an economy that isn’t in a liquidity trap, one can reasonably assume that jobs lost due to Chinese exports will be offset by jobs gained elsewhere, although that may be small comfort to the workers affected. Under current conditions, however, there is absolutely no reason to believe that there are offsetting gains — on the contrary, the losses to import competition are magnified through multiplier effects.

Like everything in economics, support for free trade should be based on analysis, not slogans. And if you’re in a situation where the analysis says normal rules don’t apply, then they don’t apply.
The idea of "free trade" is nothing more than a rendition of opportunity cost. One's production decisions are based upon the opportunity costs involved, period.

What Krugman is saying is that our situation today repeals the Law of Opportunity Cost and with it the Law of Scarcity. Thus, we are left with the head-scratching notion that goods no longer are scarce, even as people are being deprived.

(I am sure I will have a host of angry readers claiming I am putting words into Krugman's mouth. All I can say is that by debunking the Law of Comparative Advantage, which is based upon the Law of Scarcity and the Law of Opportunity Cost, Krugman is doing away with those things. There is no way around it, even if Krugman's fans don't like it.)


Pete said...

Since the doctrine of the liquidity trap is itself entirely fallacious, one can say that the economy is in a liquidity trap at any time one wants, and to the extent that one is a positivist, one is unable to refute claims that the economy is in a liquidity trap, because historical data can neither confirm nor refute any economics law or principles.

The liquidity trap therefore serves as a panacea for justifying ANY bone headed economic policy that one wants.

Inflating and spending trillions of dollars is wrong? Not when there is a liquidity trap!

Seeking to abolish the law of scarcity is wrong? Not when there is a liquidity trap!

Seeking to abolish the law of opportunity costs is wrong? Not when there is a liquidity trap!

Seeking to abolish the free market is wrong? Not when there is a liquidity trap!

Hurting innocent people through more oppressive taxation and inflation is wrong? Not when there is a liquidity trap!

The liquidity trap has been thoroughly debunked by Rothbard:


And by Richard C.B. Johnsson:


In other words, Krugman is basing his entire "depression economics" on nothing but a chimera.

Anonymous said...

What does "liquidity trap" really mean - that there are some people who don't have as much cash as they would like? That describes most people most of the time. They are "trapped" and unable to live beyond their means due to a shortage of either paper or electronic Ben Franklins, i.e. "liquidity". That's what the Krugmanites have been saying for decades now ... Asian Flu was a liquidity trap ... LTCM Hedge Fund meltdown ... Y2K ... tech meltdown ... subprime meltdown ... TBTF meltdown ... Greece ... Spain ... Italy ...

Bob Roddis said...

The “official” definition of a “liquidity crisis”:

A situation in which real interest rates cannot be reduced by any action of the monetary authorities. This is liable to arise if prices are expected to fall. If general price falls are expected, holding money will produce an expected real gain equal to the expected rate of deflation. The real interest rate cannot be reduced beyond the point at which the nominal interest rate falls to zero, however much the money supply is increased. The monetary authorities are thus unable to promote investment by cutting real interest rates, even if investment would be responsive to a real interest rate cut if one should occur.


The entire concept is so outrageously pro-Keynesian. As smart people know, the “stimulus” of monetary policy produces only an unsustainable artificial boom. Once the bust begins, prices will tend to fall to reflect reality instead of being artificially bid up by the funny money. At this point, people will want to hold (and not spend - THE HORROR!) money in anticipation of lower prices (or bad Keynesian bust times). In such a situation, the inflationists cannot induce more funny money borrowing, so, according to them, the government must spend and spend and go into debt. That’ll work.

“Liquidity crisis” really means that free people would rather save instead of spending. That’s considered a crisis to evil Keynesians who are then compelled to concoct new ways to steal people’s savings.

Lord Keynes said...

As smart people know, the “stimulus” of monetary policy produces only an unsustainable artificial boom.

Which, according to the logic of ABCT, would happen even in your Rothbardian anarcho-capitalist paradise, seeing that you have recently admitted that FRB could exist in such a system here:

"If the depositors aren’t misled and the payees aren’t misled, who cares?"


Bob Roddis said...

My "admission" assumes that nobody is misled. The gist of the ACBT is people being misled to think that their increased government monopoly funny money accounts or government monopoly FRB accounts mean a richer society as opposed to just the artificial (and immoral) shifting of purchasing power and impoverishment through malinvestment. Multiple private sources of money would limit and prevent a general price inflation in all types of money. Further, it's you, not me, who thinks FRB is the greating thing since sliced cheese.

Because you refuse to understand the concept of economic calculation and how it is the center of all Austrian thought, you keep shooting your Nerf bullets. And missing.

How many times and how many ways can I say it? If people want to use FRB, go for it. If it blows up, don't come running to me. If it works, wonderful.

Why don't we worry (right now) about how many pro football teams Detroit will support in 2078 after IP is abolished and everyone can call themselves the Lions?


And isn't it amazing that those evil hateful cultist Rothbardians have a long list of links for Michael Rozeff who disagrees with Rothbard on FRB?


Daniel Hewitt said...

LK, FRB (without a central bank) is nothing to be afraid of. If customers choose to use FRB notes as money, there would be a limit to how much inflation that would cause.


Mike Cheel said...

The problem is not federal reserve banking; the problem is that I am forced to partake in it whether I want to or not.

American Patriot said...

For the millionth time:

There is NO liquidity crisis
There is NO lack of consumer spending
There is NO capacity utilization crisis
There is NO lack of government spending



Sooner this sinks in to the progressive brain, sooner we will start true recovery.
And since that is an impossibility, recovery will have to wait till 2013!

Mike Cheel said...

@American Patriot

"recovery will have to wait till 2013!"

This seems a bit optimistic...

Django said...

Krugman in 2003:


William L. Anderson said...

Very interesting. You see, in Krugman's Wonderland, the laws of economics are determined by the current situation. That is what used to be called "Historicism."

Geekoid said...

Free trade is the ability to trade across borders without(or little) government intervention. Debunking something does not imply the underling features on what it's based on are incorrect, only the the interpretation, and model based on them has a flaw.

"ne's production decisions are based upon the opportunity costs involved, period."
In a perfect world, yes. But that's not what happens. On'es production decisions can be influenced by many other factors, not just opportunity cost. Unless you make opportunity cost so vague is become meaningless.
Good can be abundant AND people can be deprived. How many people go hungry in America, even though we have plenty of food to feed everyone 3 good meals a day, with dessert and snack.

Anonymous said...

Professor Anderson, a question- when I took economics (admittedly many years ago), we talked about models, and we talked about what behavior various models captured, and we talked about markets.

It is my understanding that interest rates could be thought of on some level as a measure of opportunity cost. i.e. if I loan out money, I charge based on the forgone opportunities. If we trust markets, don't we have to believe that right now, opportunity cost as at an all time low? i.e. rates on government bonds are negative in real terms. It seems as if the bond market is paying the government to borrow their money.

In short- you say don't trust Krugman, I'm fine with that. BUT you seem to also be saying "don't trust the market", and as an Austrian, isn't this a weird position for you to be taking?

Tel said...

Anonymous (October 6, 2011 12:20 AM):

Which interest rates are you looking at as being market driven? The interest on home loans? The interest on credit cards? or business overdraft?

Or are you looking at the T-bill rate where there is one massive seller in the market and one massive buyer and the seller and the buyer are closely related? Are you looking at those interest rates?

And how are you allowing for elements of the money market that simply are not clearing? For example, people who want to buy a house but find the banks unwilling to lend. What about those situations? What is the effective interest rate?

Pete said...


Interest rates do not "measure" opportunity costs.

Interest rates are not market driven in the US economy.

William L. Anderson said...

To the 12:20,

Yours is an interesting question, but you have to ask yourself if the rates on government paper right now are being shaped by (1) time preference and (2) market behavior, or are they being shaped by the actions of the Fed.

There is another point that I think is important to make: U.S. Government bonds are being paid back mostly with money gained from sale of more bonds. This is illegal for states and municipalities and corporations.

What if these rules also applied to the federal government? Do you think that the interest rates would remain near zero?

Anonymous said...

The price of bonds should be controlled by the marginal bond purchaser, so I would say your "1" and "2" have a stronger impact on the bond price then Fed actions.

But lets not look at government paper- AAA corporate paper also has historically low rates- which should suggest opportunity cost is very low. No one has any thing useful to do with their money.

To what extent are Austrians willing to take markets seriously?

Pete said...

Lord Keynes has started to censor posts over at his blog.

In case anyone posts there and they don't see it, that's the reason.

When statists/Keynesians are refuted time and time again, they can only resort to censorship.

Bob Roddis said...

Yes, it seems that LK has even admitted to censoring his blog. He apparently won’t post this:

LK's entire narrative depends upon a purposeful failure to understand the central Austrian concept of economic calculation. Just as economic calculation is impossible under socialism, economic calculation is impaired by the artificial creation of money and credit. HOW that impairment will play out is a question of fact. It has long been MY OPINION that more complicated investments and investments that must play out over longer periods of time will be impaired more than less complicated investments that take place in a shorter period of time.

Housing fits completely within that theory, especially since the financing of housing takes place over the long term. Further, one of the main incentives to purchase housing was that it was perceived as a hedge against inflation. Since most people go to government schools and tend to believe that inflation is a mysterious force of nature instead of purposeful Keynesian policy, they have no ability to understand the concept of an artificial and unsustainable Keynesian boom. They are like sheep going to the slaughter.

The fatal problem with Minsky is again the purposeful refusal to understand the ubiquitous and very specific problem of economic calculation which is replaced by Minsky with an amorphous and unintelligible theory of speculative euphoria but which ignores its self evident cause, FRB and/or fiat money resulting in impairment of economic calculation, especially over the long term.

Jeff said...

Can you provide any insights into how William Baumol integrated entrepreneurship into Keynesian economics?