GM -- "burning the furniture in order to stay warm"

December 12, 2008 9:37 AM by Greg Ransom

Think of General Motors as the metaphor of the Keynesian economy in one company -- massive simultaneous spending on unsustainable capital investment and unsustainable consumer consumption. Or as Bloomberg reporters Doron Levin and John Helyar describe it, "burning the furniture in order to stay warm."

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The Austrian Business Cycle -- Evidence From Bolivia

December 3, 2008 12:21 PM by Greg Ransom

Economist Thorsten Beck posting at the World Bank CrisisTalk Blog:

The loose monetary policy in the first years of the 21st century has been one of the culprits for the boom and subsequent bust in the U.S., but rigorously testing this hypothesis is difficult .. But perhaps we can learn something from a small open economy for which monetary policy decisions can be considered exogenous. A recent paper by Vasso Ioannidou, Steven Ongena and Jose Luis Peydro does exactly this, using a unique dataset on Bolivian borrowers. During the period 1999 to 2003, the local currency was pegged to the U.S. dollar and the relevant short-term benchmark rate was the U.S. federal funds rate. The paper shows that reductions in short-term interest rates do indeed lead to excessive risk taking by banks, which can eventually lead to banking fragility when interest rates rise back to "normal" levels.

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Must The Central Bank Be The Source Of An "Austrian" Boom And Bust?

December 1, 2008 12:02 AM by Greg Ransom

Many economists seem to think that the Austrian Theory of the Business Cycle is an explanatory projected circumscribed by its dependence on the identification of lose money created by a central bank as the necessary explanans for the boom and bust cycle.  But this is not Hayek's view, and a careful reading of Hayek makes is clear that Hayek considered other sources of the misdirection of capital through the time structure of production as equally valid generators of the artificial boom / inevitable bust pattern of the trade cycle.  In Hayek's view, the mere fact of the elasticity of the supply of credit in the private banking system makes it possible and likely that spikes in the supply of investment cash can set in motion expansions of credit that are unsustainable across the time structure of production and consumption.  Misperceived price signals in the credit system are quickly embodied in real goods -- such as capital goods -- becoming systematic distortions of the system of relative prices across the structure of production and consumption.

To put this in contemporary terms, a spike in investment cash from China and other Asian countries could set in motion a much more massive credit expansion by Western financial institutions far beyond anything warranted by this infusion of fresh investment capital, setting in motion unsustainable distortions across the time structure of production and consumption as described by the Austrian theory of the artificial boom and inevitable bust.

Hayek's rejection of lose monetary policy by a central bank as the necessary and exclusive explanans of the Austrian trade cycle theory can be found in Lecture IV of Hayek's Monetary Theory and The Trade Cycle.  Find there also Hayek's example of an artificial boom / inevitable bust cycle generated by private commercial banks rather than by a central bank.

From Hayek's perspective then, Jeffrey Rogers Hummel, Tyler Cowen and other economists are offering up a false dilemma when they suggest that an Austrian account of the current boom and bust must stand against an explanation of recent events which appeals to a spike in investment cash from China and other Asian countries as a central cause of the current boom and bust.  They are wrong to suggest that an Austrian explanation of the current boom and bust cycle must necessarily invoke monetary policy on the part of the Federal Reserve in its explanation, and they are wrong that an Austrian explanation cannot invoke the spike in investment cash from Asian as a trigger for a credit induced over-expansion which creates unsustainable distortions across the time structure of production and consumption.  A sound Austrian explanation might invoke the Asian investment spike alone, or it might invoke both the investment spike and Fed policy.  Or it might invoke Fed policy alone.  Theory doesn't rule in or out these alternatives, historical investigation and explanatory plausibility does.

Click in the extended section for quotes setting out the false alternative imagined by Hummel and Cowen, as well as a brief section from Hayek in which Hayek clearly rejects the identification of the Austrian theory solely with explanations that make essential appeal to central bank policy.

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