Producing Assets Uses Resources that Could Have been Used to Produce Consumption Goods and Services

"This claim contains a modicum of truth resting atop a mountain of misunderstanding."

This is one of the best sentences I've ever read. I might be forced to use this (with proper attribution, of course) myself at some point.

Don writes:

"What’s true is that the supply of money should be prevented from collapsing relative to people’s demand for money. But beyond this, policies to “support consumption and asset markets” cause trouble."

Don, you tell Mr. Samuelson that his "claim contains a modicum of truth resting atop a mountain of misunderstanding," when, in fact, so does your claim above.

Keeping the money supply commensurate with the demand for money is not enough in the short-run when an economy is weak, especially when it is extremely weak and has suffered from a violent financial crisis.

If your assertion were enough, we would need interest rates to remain more or less unchanged, when, in fact, the right prescription for the economy is for interest rates to decrease which is accomplished with an increase in the money supply above and beyond the demand for money. Even today, after our horrific financial catastrophe, the Fed had to create other unorthodox solutions to save the financial system, and with it, the macroeconomy.

Therefore, a countercyclical monetary policy is crucial to stimulating aggregate demand, which involves targeting lower interest rates, and, once at the zero bound, possibly switching over to reserves if further expansionary policy is called for.

So Don, your claim contains a modicum of truth resting atop a mountain of misunderstanding in the short-run. Only in the long-run, when we achieve monetary neutrality and the natural rate of interest, should the money supply be entirely consistent with the money demand.

And no, it doesn't "cause trouble" unless of course, one naively believes in Austrian Business Cycle Theory which I have discredited multiple times on this blog (Do a search for Pingry).

Let's be clear about something here: Recessions are never needed for anything, period. Bad decisions and so-called "malinvestment" can be taken care of at full employment.

To believe otherwise is to have blind faith in the invisible hand in a recession, when it is weak, instead of at full employment, when all resources prices are flexible and uses are variable, and the invisible hand is strong.

--Pingry

Isn't this just more structure economics? Not being able to believe in the "invisible hand"?

In order for your premise to be correct the Fed must be able to give us the "natural interest rate" which by definition is hard to say with a straight face when the Fed is setting it as opposed to the open market. I know, the name has been hijacked but outside of the Stockholm syndrome I don't see the Fed being a natural force in setting the interest rate. I think that becomes your own "modoicum."

Pingry,

Your analysis appears to be built on the assumption of an economy producing GDP widgets or some other amorphous blob of undifferentiated “goods” that are manufactured using capital with a “K”.

But none of that is true in reality. In reality, it appears that a modern capitalist economy is composed of highly complex, highly specific structures of capital goods that are complimentary in often very specific ways. A GM factory isn’t costly converted into a windmill factory just because you expand the money supply. Human capital is specific too, though much more flexible than auto assembly robots. If you’ve spent your life learning how to operate an auto assembly robot productively, there’s likely to be some time after a career change during which you retrain before you’re productivity and value can match your former skills.

So when excessively loose monetary expansion (both central bank driven AND private bank driven) leads to a temporary boom in ALL goods, the reality is that some of those industries MUST see a fall in demand as the economy adjusts to the higher input prices and interest rates (assuming the central bank fights the ensuing inflation). These firms will be forced to write down their capital. That GM plant must, sadly for them, liquidate if there isn’t sustainable demand for its output. That liquidation allows capital to move into the uses that are hopefully sustainable.

The aggregate approach you’re suggesting seems utterly blind to the cost of sectoral shifts, relative prices and demand and capital devaluing. It’s all just GDP widgets built with K. There’s a reason durable/capital/producer’s goods prices go through a larger boom and bust than final consumer goods. Keynesian/monetarist macro doesn’t seem to account for that fact at all.

Moreover, your claim that "Recessions are never needed for anything” is mighty confident given that all of industrial history has continued to have them. The “we just didn’t do a big enough stimulus” counterargument is the height of unfalsifiable scientism. Still, in a sense, I completely agree. So what’s the answer? DON’T START A BOOM WITH CHEAP MONEY.

It’s the rising input costs that burst the bubble. A hair of the dog doesn’t fix that problem, it just shifts it using the redistributive power of inflation.

The invisible hand may get confused when a credit expansion clusters business errors and thus dumps the entire economy into a period of search for new opportunities all at once. Adding more noise to the signal with additional inflation only makes that discovery process that much harder that much more likely to be in error once more.

Countercyclical monetary policy, aiming to stabilize nominal income to prevent a secondary contraction, is a separate issue from REAL “depression prevention”.

Depression prevention means preventing unsustainable booms and the sectoral shifts that inevitably follow.

But I might be wrong, since I’m an amateur. The Austrian story just makes more sense and seems better supported by reality than the “hair of the dog” perpetual boom story to me.

Lollapalooza,

Excellent analysis.

But I ddnt' like this statement at the end.

"But I might be wrong, since I’m an amateur."

You're a lot more right than most professionals.

And no, it doesn't "cause trouble" unless of course, one naively believes in Austrian Business Cycle Theory which I have discredited multiple times on this blog (Do a search for Pingry).

Proving something to your own satisfaction is not the same as proving it to the satisfaction of others. (discrediting is a form of "proof")

Your logic chain may be a sound as a rock, but your premises are another matter.

Sam,

When I said that I agreed with Ping, I meant with has assertion that there didn't need to be unemployment. But that assumed that inflation had been the only act of intervention. For, in an otherwise free market, there would still be no unemployment. While the capitalists lost their investments, their displaced workers would simply move on to other, lower paying jobs.

The greater unemployment during a recession is a consequence of the fact that the boom period of the boom and bust cycle had masked an unemployment problem that already existed, and the bust simply exposed it.

For example, while a minimum wage law had raised wages above the free market, equilibrium, full employment level, the level at which there could be full employment, the inflation reduced real wage rates back to equilibrium, full employment levels. But, then, the deflation raised them again to disequilibrium, unemployment levels.

If you're not going to reinflate, and not repeal the minimum wage law, and other deterrents to employment, how will the unemployed ever get reemployed? Only through more investment and the increasing productivity of labor.

Reminds me of my agreement with a certain leftist claim that people could work a 30 hour week with 40 hour take home pay, my disagreement is in how to effect it. Leftists would mandate such an outcome, that is, by fiat, while I think it could be accomplished by reducing the burden of a redistributive state.

http://www.econotrashtalk.org/The Cause and Cure.htm

..been there, referred a friend to it; he found it VERY interesting.

Sam,

Do you mean Cause and Cure of the Depression?

Tried to create a link directly to it, but thought I couldn't do it.

His mother is Jewish and he's libertarian and Austrian in economics.

Saml

I don't who or what you're talking about.

My very good friend, Greg. Of course you don't know him.
After reading some of your site, he wrote back saying it seemed like the book he should've written.

Thank you for the kind words. Coming from you, they mean a lot.

DG Lesvic,

Enjoyed the book, thanks.

Thanks, Captain.

How about Pocohontas?

I guess that broad's history.

RE: "Proving something to your own satisfaction is not the same as proving it to the satisfaction of others."

EXCELLENT point. It should be raised more often here.

Yah, and you'd be dead.

Prof Boudreaux,

You wrote,

"the supply of money should be prevented from collapsing relative to people’s demand for money."

I suspect that you are confusing marginal with total demand for money.

When production rises, and there are more goods relative to the supply of money, there is more demand for each dollar, but not for more dollars.

Since the greater demand for money is really for more saving, "increasing liquidity" and reducing the value of savings would not be "meeting" but thwarting the real demand, for a reliable means of saving.

Deflation is a corollary of saving, and that is just what is needed, especially during a recession, and with more destructive policies on the way, saving capital from the oncoming avalanche, and for recovery, where opportunity appears. And, the more saving, the more opportunity, the more deflation, the more recovery.

Whereas the deflation gets the market out of the way of the avalanche, the reinflation keeps it there, and, the deflation is essential to recovery, the reinflation cuts it off, maintaining wasteful spending, and leading to a greater collapse later on.

A recession is the reestablishment of consumer preferences. And since there cannot be a recovery without it, the recession must be allowed to run its course and the market find its bottom. Keeping it from hitting bottom just keeps it from starting back up again, prolonging and deepening the agony, and turning a recession into a depression.

Ping Pong,

You wrote,

"Recessions are never needed for anything, period. Bad decisions and so-called "malinvestment" can be taken care of at full employment."

I agree. While capitalists lose capital, there is no reason why, in a free market, their employees couldn't find other jobs right away.

In a free market, the recession would be a micro disaster, limited to those who had lost their capital. It is only interference with the market that turns the micro into a macro disaster. The problem is not the mistakes in the market itself, but the political reaction to them.

1. I assume you consider "sound" money = gold based currency. How do you prevent the supply from collapsing? Nobody can create new gold.

2. Why to prevent the supply from collapsing? If I have $100 that buy me a dinner or if I have $1 that buys me the same dinner, what's the difference?

3. What is the difference between assets and consumption? Isn't it only the intended use? If I buy a new car, is it an asset or consumption?