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If I Believed in Austrian Business Cycle Theory, part II
Karl, a loyal man, has a request:
In your post from a few years ago, "If I believed in Austrian business cycle theory," you made some of the most apt predictions you have made on this blog. Nearly everything has come true. Obviously though you are not touting these predictions because being associated with the "intransigent" Austrians will damage your credibility as a hip, quirky thinker. So instead, can you just give me a socio-economic cost-benefit analysis of breast implants.
Here is my original post. Two points:
1. What happened is best thought of as a bubble where loose monetary policy was one of several triggers but the market response was more at fault than was government.
2. Second, one important false market signal was that people thought rising asset prices could substitute for savings out of disposable income. That is not the Misesian or Hayekian scenario.
My "predictions in the subjunctive" were largely correct -- more correct than I knew at the time -- but that doesn't mean Austrian business cycle theory is largely correct. I would, however, endorse a modified version of the theory which goes beyond the "blame the government inflation" for everything interpretation.
On Karl's other question, it's not just a zero-sum game, socially speaking, but my personal preference would be for Q = 0.
Addendum: Walter Block wrote a 58-page critique of my earlier writings on ABC. He has sent it to me twice and I am happy to link to it. Update: Here is the correct Block link.
Posted by Tyler Cowen on August 25, 2008 at 10:01 AM in Economics | Permalink
Comments
The link in the addendum is a bad one; it should properly link to http://pcpe.libinst.cz/nppe/2_2/nppe2_2_2.pdf
Posted by: Frank at Aug 25, 2008 10:28:48 AM
Your link to Walter Block's critique is not working.
Posted by: MPH at Aug 25, 2008 10:35:42 AM
"He has sent it to me twice..."
That's our Tyler, always good for the subtlest digs.
Posted by: mk at Aug 25, 2008 10:56:50 AM
Am I correct that this is non-controversial?
Posted by: odograph at Aug 25, 2008 11:10:30 AM
Reread original post. Not bad but what happened to #7?
Posted by: Martin at Aug 25, 2008 11:27:16 AM
Tyler wrote:
Second, one important false market signal was that people thought rising asset prices could substitute for savings out of disposable income
I have seen the written in several places, including here previously, and I must admit that I am confused. You put your savings into assets. The relative value of those assets against consumables will rise and fall- if they fall you need to save more out of disposable income, if they rise in relative value, you can save less. Why is this contraversial?
Posted by: Yancey Ward at Aug 25, 2008 11:36:29 AM
Yancey, I think it is controversial because people treated a rising home value as free money. That is, if their house gained $$ in potential resale value, they treated that like a lottery ticket that had just paid $$, and spent money that was deceptively illiquid and uncertain.
Posted by: Erik Knechtel at Aug 25, 2008 12:00:44 PM
Are you sure that linked document wasn't written by David Foster Wallace?
Posted by: angus at Aug 25, 2008 12:10:51 PM
Point 1 is just plain wrong. The government was entirely at fault. All the shenanigans by banks and mortgage companies were caused by the Fed's distortion of interest rates--which distorted their calculations and induced them to "play or pay." If they didn't "play," they'd lose market share and the managers might lose their jobs.
As for point 2, Mises and Hayek wrote long before the rise of credit cards, loan securitization, and even before Fannie and Frauddie, er Freddie. Their basic theory is correct, and the housing/mortgage boom and bust has followed the ABCT's outline. They would have been cognizant of this point had it been on their institutional radar at that time.
Posted by: Bill Stepp at Aug 25, 2008 12:16:36 PM
Erik/Yancey I think there are two parts. One is the wealth effect that we all feel when our assets rise. The other was the dangerous idea that borrowing against rising assets was the same as cashing them out. People "took money out" of mortgages by borrowing against them. Some even borrowed against their 401Ks.
I think Tyler refers to just the wealth effect in #2 above, and the excess borrowing in #1, "market response was more at fault than was government."
Posted by: odograph at Aug 25, 2008 12:26:40 PM
Bill, do you think the people who took second mortgages to buy large SUVs have any personal responsibility, should they now find themselves doubly under-water?
Posted by: odograph at Aug 25, 2008 12:28:22 PM
One difference between housing and securities is that it is easy to cash out increases in securities (sell them), whereas the primary method of cashing out increases in housing prices was a second mortgage, i.e., to borrow against the increase. Maybe the answer is to create a way of creating liquidity in housing assets that does not involve borrowing.
Posted by: Norman Pfyster at Aug 25, 2008 12:55:41 PM
As I understand ABC theory, the malinvestment is caused by market actors being fooled by price signals, price signals which are distorted by government inflationary forces.
Given this emphasis on foolish investment caused by distorted prices, Tyler's claim that there was an "additional cause" for which the market is to blame is nonsensical. Of course market actors were fooled -- but that's the essence of ABC.
In the fantasy world of rational expectations money should not matter -- but that just means that a lot of mainstream macroeconomic theory is garbage.
Posted by: Alex at Aug 25, 2008 1:01:47 PM
Monetary Nationalism and International Stability is available for download (PDF) from the Mises Institute. No need to shell out $70.
http://mises.org/books/monetarynationalism.pdf
Posted by: Eric at Aug 25, 2008 1:18:40 PM
Odograph and Erik,
I agree that borrowing against the asset in order to consume can be foolhardy, but that is not what Tyler and others have criticized in this case, and if it is this kind of debt they meant to criticize, then they wrote poorly.
There is nothing irrational about modifying one's saving ratio to reflect changes in value of the assets purchased.
Posted by: Yancey Ward at Aug 25, 2008 1:25:14 PM
"On Karl's other question, it's not just a zero-sum game, socially speaking, but my personal preference would be for Q = 0."
I mostly agree, but have to admit that Q = 1 would be hilarious.
Less jokingly, while I don't often bring the subject up, I've never spoken to a man who has said that he would prefer that more women (or his own wife/girlfriend/unattainable love interest) have them. Obviously, this is not a rigorous study, and inferences about the population at large should be made cautiously, if at all. However, assuming (why yes! I did study economics) that the majority of men are of Tyler's persuasion on this issue, why do so many women have them? I can think of a few different possible explanations:
1. Because the subject doesn't really come up all that often (possibly because it is taboo in most social scenarios), women don't know that implants yield no competitive advantage (or perhaps even yield a disadvantage). They erroneously assume that implants will lead to more male attention.
2. Men are liars; implants are an effective strategy.
3. Men are delusional; they don't realize that they prefer women who either have implants or are likely to have them.
4. Women are at least somewhat aware of the ineffectiveness of implants for gaining male attention, and get them just to piss off their female peers.
4(a). The ability to piss off their female peers makes women with implants more confident, and therefore more attractive to men. Implants are an effective strategy, but only indirectly.
5. Women get implants for the heck of it, having nothing to do with what others think of them.
Posted by: d.cous. at Aug 25, 2008 1:33:42 PM
Visually appealing, less so on contact.
Posted by: Yancey Ward at Aug 25, 2008 1:42:26 PM
So, after almost two decades of easy Al, who not only kept interest rates at rock bottom, but also bailed out anything that might have even tested the 'stable, modern financial system', we're going to blame market actors for acting irrationally? I would argue that they did act rationally, under the assumption that the Fed would bail them out (they have been proved correct on that assumption, via many different mechanisms, too many to list). What they did not bank on was that the problem would get too big for the Fed to bail. 25 years of a relatively uninterrupted bull market in all things Wall St Finance will do that to you.
The main problem with explaining moral hazard is that it is so hard to quantify. Thus, most people will brush it to the side as something only moralizers and ideologues should deal with. One need only look at the most recent actions of Bill Gross and PIMCO to see just how rampant moral hazard has been ignored, to the detriment of the US taxpayer.
Posted by: Danny Kenny at Aug 25, 2008 2:06:09 PM
"2. Second, one important false market signal was that people thought rising asset prices could substitute for savings out of disposable income. That is not the Misesian or Hayekian scenario."
This is just plain wrong. In both his Theory of Money and Credit and his Human Action, Mises emphasized the pivotal role played by the "illusory" profits generated by the falsification of accounting that occurs during the boom stage of the business cycle. (He also recognized, unlike Tyler, that since assets are alienable, saving via a rise in asset prices is indistinguishable from saving out of so-called "disposable income.") These false accounting profits result in capital consumption (i.e., a reduction in real saving) among all income classes in the economy, in particular as a result of "the in rise prices of stocks and real estate." As a result, businessmen, stock jobbers, wage earners--all "feel lucky and become openhanded in spending and enjoying life." (HA pp. 546-47).
Hayek too recognized the increase of asset prices as identical with an increase in current profits, that is, disposable income. In pointing out an error of Keynes, he wrote: "But these two functions [of capitalist and entrepreneur] cannot be absolutely separated even in theory, because the essential function of the entrepreneurs, that of assuming risks, necessarily implies the ownership of capital. Moreover, any new chance to make entrepreneurs’ profits is identical with a change in the opportunities to invest capital, and will always be reflected in the earnings (and value) of capital invested" (Hayek, “Reflections of the Pure Theory of Money of Mr. J. M. Keynes.” Part I. Economica, No. 33 (August) p. 277.
Posted by: cleric at Aug 25, 2008 2:12:51 PM
Nice job cleric. I was going to try to make the same points, but probably would have screwed it up.
Posted by: chanceH at Aug 25, 2008 2:58:04 PM
I think Yancey is correct: There isn't anything irrational about borrowing against assets that have raised in value. Whats foolhardy is treating that value as if it was permanent when its not. But how were borrowers and lenders to know what the "correct" prices should be? They were receiving false signals, and acted on them.
I also think its crazy to suggest that ABCT doesn't have some explanatory power with regard to the housing bubble. It certainly doesn't explain everything (you'd have to model tons of political, regulatory and institutional frameworks for that), such as why all the money went into housing. If you think banks don't have strong incentives to make more loans when interest rates drop, I think you're crazy.
Posted by: Grant at Aug 25, 2008 4:01:45 PM
I've never spoken to a man who has said that he would prefer that more women (or his own wife/girlfriend/unattainable love interest) have them.
I never look at a woman and say, "I wish she had breast implants," but I often look at one and say, "Look at those boobies!" Whether I advocate them and whether they are effective for the women who get them are two different things.
Posted by: Noumenon at Aug 25, 2008 4:17:13 PM
There was no (relatively) inflation, therefore there is no realignment of consumers spending (yet) and no recession (though if one keeps predicting recessions for YEARS one will eventually be right) therefore it is not proof against Austrian business cycle theory.
The government has plenty of blame, and the businesses have blame. It's not that the market doesn't make mistakes, its that the market finds them and fixes them. And the government so far has done what? Sent out a bunch of checks. Solidified the positions of the companies that are "too big to fail." Btw, when did that phrase move from hubristic, as in the Titanic, to pejorative, as in the Titanic, to a self-reinforcing prophecy?
Posted by: Andrew at Aug 25, 2008 4:46:09 PM
d cous,
what about statistics on whether women with breast implants make more money than those without, in e.g., the erotic dancing or film industry?
Not a perfect statistic, but better than anecdotes. It could only, at best, indicate whether men like them for women whom they consider only on a sexual level. But women may care about this factor.
It is also only a relatively small percentage of women who choose to get them, isn't it?
Posted by: liberty at Aug 25, 2008 5:19:20 PM
Alex,
"As I understand ABC theory, the malinvestment is caused by market actors being fooled by price signals, price signals which are distorted by government inflationary forces.
Given this emphasis on foolish investment caused by distorted prices, Tyler's claim that there was an "additional cause" for which the market is to blame is nonsensical. Of course market actors were fooled -- but that's the essence of ABC."
I agree....at least that's how I understand the ABC Theory broadly interpreted.
I'm not sure if Tyler is sticking to a more stringent definition centered on capital goods or if there is something beyond the laymen's interpretation that we are not considering.
As I scrolled, I was hoping Tyler would have addressed your comment or others like it.
So far, not yet. Come on, Tyler. Talk economics to us. Tell us why ABC is not applicable here....if not at least incomplete.
Posted by: John V at Aug 25, 2008 8:23:16 PM
