On Sunday, January 12, 2003 2:01 AM David Levensam [EMAIL PROTECTED] wrote: Fred Foldvary wrote: > <<Too much financial capital, i.e. money, can cause > a recession, by artifically lowering the interest rate, > inducing excessive investment of those capital goods > for which only a low rate of interest is profitable. > Since intended consumption has not changed, > consumers compete with investors for goods, > driving up prices. The capital goods turn out to be > unprofitable investments, and the diminution of > investment leads to a downturn.>> > > This is standard Austrian business-cycle theory, which > is why I said that too much borrowed capital can cause > a recession. It also works under standard monetarist > theory, with too much money driving up the general level > of prices, causing a false boom, which then collapses > into recession after peopel figure out that only nominal, > not real, aggregate demand has risen.
Actually, Austrian Business Cycle Theory (ABC) is a bit more sophisticated than that. It's closer to what Fred says above. It's not too much capital, but distortions in capital. To Austrians, capital is heterogenous not homogeneous -- not an undifferentiated blob of stuff, but a complex set. Looked at this way, certain sets of capital work better together than others. Add time into the mix and we have certain sets of capital working better than others to ultimately produce consumer goods and services. In ABC, the interest rate affects which capital structures will be chosen. In general, a lower interest rate allows for lengthier production schedules while a higher one makes for lower ones. In other words, lower interest rates allow for longer ranged planning and higher ones disallow that. The problem in ABC, of course, is not merely setting the interest rate -- else then why not have the government come in and mandate a zero or negative rate so we get increasing intensification of capital -- but having a sustainable interest rate, viz., one matching investment and saving decisions. Lowering the rate below the stock of savings -- below the "natural rate" creates an inflationary situation that is unsupportable in the long run -- leading to business cycles. (A higher than natural rate leads to a deflationary situation which involves a deintensification of capital.) If this were the whole story, it would be bad enough, but since capital is hetergeneous in more than just the temporal sense, the path inflation takes through the economy varies. So one can't necessarily predict ex ante how an inflationary boom will proceed. Generally, whoever gets the expanded credit first will get the most benefits from it and prices will rise in that industry first. For example, imagine an economy with 10 different sectors -- A, B, C, D, etc. Let's say industry A gets the influx of new credit first and that it buys directly from industry B while B buys directly from C and so on. Credit expansion will benefit A first, allowing it to buy more from B, driving up prices in B and, after a time lag, investment in B. B will buy from C, likewise driving up prices and investment after a time lag. This distorts the whole price structure because of the time/information lag. Since we're presuming the expansion is unsustainable, eventually there has to be a correction, but this does not necessarily recover all losses. I.e., it doesn't reverse all the damage. This scenario might be playing out now in the homebuilding industry. Low interest rates have given incentives for people to buy bigger mortgages spurring lots of new, expensive homebuilding. If the real estate boom lasts long enough to build the homes, the initial homebuilders will make a profit, but imagine a few months after that the market collapses. Later building projects will fail and also home buyers who planned to sell later will lose out and if this brings about another recession, some of them might not be able to meet the mortgage payments. Etc. > <<There can be too much real capital invested > in particular types of capital > goods.>> > > Sure, because people aren't perfect prognosticators. If they were, there would be no economic problems period and no need to worry about this stuff or anything for that matter.:) > To cause a recession, however, wouldn't such > misinvestment have to be systemic? What would > cause such systemic misinvestment--everyone making > large mistakes at the same time--beyond government > manipulation of the money supply? Government manipulation of the money supply -- through control of interest rates as well as reserve requirements, selling bonds, and even deficit spending (since that impacts market rates to a big extent because the government is a big debtor in most extant economies) -- is a large part of the story according to ABC. Malinvestments per ABC happen in basically the above fashion. Government interference in the money supply allows for widespread distortions in the capital structure and in planning for individuals across the whole economy. Why? Money is the most traded good in any advanced economy and a linkage between almost all transactions in such an economy. Government manipulation in this area is not the whole story, but it kicks off the process. (It also disallows or postpones adjustments.) Two recent books, _Microfoundations and Macroeconomics_ by Stephen Horwitz (http://it.stlawu.edu/shor/Book/Book.htm) and _Time and Money_ by Roger Garrison (http://www.auburn.edu/~garriro/tam.htm)cover this area. You might do well to check them out. [Shameless plug: I reviewed Horwitz's book for _The Thought_. My review is online at http://uweb.superlink.net/neptune/Macro.html ] Whether ABC is true here or is the whole story is another matter and I hope to see it discussed here. (BTW, both of the above books were discussed on Hayek-L. See http://www.hayekcenter.org/friedrichhayek/hayek.html for details on Hayek-L and its archives.) Cheers! Dan http://uweb.superlink.net/neptune/
