Friday, June 29, 2012

Austrian Macroeconomics on Economic Depressions with a Monetarist Twist!

This is a quotation from Richard M. Ebeling's Austrian Macroeconomics:  Review of Roger W. Garrison's Time and Money.

What is going on here is this:  Ebeling first provides the standard Austrian School explanation of economic depressions.  This is the story involving the money supply being artificially increased followed by the artificial lowering of the market interest rate.  This then causes resources to shift into producing long-term investment projects as opposed to consumer goods production.

Then, he mentions an objection raised by Sir John Hicks.  Hick argues that the traditional Austrian theory cannot be the explanation of depression because the economy, based on this theory, will self-correct too quickly, i.e., a serious investment boom could never really start up and get going.  Resources would quickly shift back to the consumer goods industry from the longer-term investment projects and the "boom" in the longer-term investment area would quickly come to an end.  However, since long-term investment booms have started and have lasted for some time, then there is obviously a problem with having a theory that does not allow for the boom phase to even get started.

Then Ebeling mentions Roger W. Garrison's proposed solution to this problem.  Garrison brings in ideas from the Monetarist school in order to "stick a time delay" into the model.  Then, with this "time delay" a prolonged "investment boom" will occur, to be followed by the "bust" part of the business cycle.

Here is how Ebeling puts it (all emphasis is mine):

Garrison retells the Austrian story by taking his cue from the type of analysis used by the Monetarists in explaining how in the short-run a monetary expansion can push unemployment and resource use BELOW the "natural rate of unemployment."  In the short-run, an economy always has some slack, even when it is operating at "full employment."
Garrison argues an economy has the capability of temporarily functioning BEYOND its "normal" full employment production possibilities.  This, he says, is what enables the investment boom to continue for a significant period of time before the "self-reversing" process of rising consumer demand brings the investment boom to a halt.
 The longer-term investment projects CAN CONTINUE for a prolonged period of time because simultaneous with this, the short-term slack in the economy enables consumer goods production to expand as well, delaying any reduced supply of consumer goods and a rise in their prices sufficient to swamp the investment boom.
 Let me try to put this into my own words.  In the standard Austrian model of depression here is what happens.

  1. The monetary authority expands the money supply and creates an artificially low market interest rate. 
  2. Investors (assuming "elastic expectations," i.e., investors will react to the lower interest rates and start investing in longer-term projects) are induced to borrow and invest in longer term projects (as opposed to shorter-term projects and consumer goods production)
  3. To invest in these longer-term projects, they have to "bid away" resources (labor, tools, equipment) from the other shorter-term and consumer goods industries.  
  4. The factor owners (owners of the factors of production) in these longer-term industries are making really good large monetary incomes.  They want to spend their money on consumer goods.
  5. The problem is this:  if the factors of production have been shifted to longer term projects then obviously they are not available to work on the shorter term and consumption goods projects.  In other words, if the workers and machines are all dedicated to building bridges they cannot be dedicated to building consumer goods. 
  6. So now the pent up demand for consumer goods will tend to bid up prices for consumer goods.  Also, consumer goods manufacturers, seeing the potentially much higher prices, can bid up wages and other payments to factors in order to shift the factors of production BACK to the consumer goods producing industries.
Now, Garrison wants to introduce a "time delay" into his model in order to explain the prolonged investment boom.  To do so, he brings up this Monetarist idea of SLACK in the economy.  With slack (e.g., marginal workers, people working overtime, factories being used below 100% of capacity and so on), the economy can expand in BOTH sectors, i.e., the longer-term investment boom can happen AND more consumer goods can also be produced!  In the traditional version above, resources would have to "shift back" from the longer-term projects TO the consumer goods production section.  But, if the economy can tap into this "slack," then the resources DO NOT HAVE TO SHIFT BACK RIGHT AWAY.  The resources dedicated to the longer term projects can STAY THERE; the slack can fill the needs to produce the additional consumer goods demanded.

That is my interpretation of what Ebeling wrote about Garrison's model. 


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