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Don’t mention the A-word

By Lorenzo

The Eurozone, the US, Japan and the UK are all suffering prolonged economic stagnation. [You can see how serious it is in the US here.] It is sensible to suggest that they are doing something (or perhaps many things) wrong and need to change policy.

What is not sensible is ignoring a developed world economy that has conspicuously not suffered any of the economic stagnation problems that have hit the major developed economies. Indeed, has not had a recession (in the sense of two quarters of economic contraction) since 1991. That sailed through the Great Recession and Global Financial Crisis (aka GFC) with barely a ripple. Whose current problems are not of economic stagnation but of maintaining economic balance when one part of the economy is doing much better than another.

That country is Australia. Yes, it is true that the surge in commodity demand (centred on China) has been a boon to the Australian economy (well, to the commodity exporting States; the resultant surge in the value of the $A has been a problem for the tourism-and-goods exporting States—the commodity boom has been a distinctly mixed blessing). But Australia had also managed to avoid recession even when its terms of trade (the ratio of the price of what it sells to the price of what it buys) were in long-term decline and when commodity prices dropped dramatically at the onset of the Great Recession. Indeed, the fall in Australia’s exports as a % of GDP was worse than the US’s.

Yet the Australian success gets mostly ignored. A classic example is Raghuram Rajan’s recent piece in Foreign Affairs. (Non-gated version here [pdf].) Much of what he has to say about the desirability for supply-side reforms is sensible. Indeed, much of what he advocates Australia has already done; which makes the failure to mention what should be the poster-polity for what he is advocating all the more of a glaring failure.

The problem with mentioning Australia is that it does not conform to the stories that Rajan and others want to tell about what went wrong. Rajan essentially ignores monetary policy, both in the commonly offered solutions to economic stagnation (fiscal stimulus and even-lower interest rates: interest rates are a very limited way of looking at monetary policy) and in diagnosing why the economic stagnation descended. So Rajan writes:

today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side.

Australia has done a lot of supply-side reforms, so perhaps it can be ignored.  Except Rajan goes on to say:

For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition and to pay for the pensions and health care of their aging populations. So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.

Does anyone really think Australia just magically averted such structural problems, that its economy is somehow profoundly different from other developed countries? Given its per capita GDP growth has been respectable but not outstanding. In particular, while its public finances were much sounder, with public debt reduced to very low levels, enthusiastic embrace of private debt meant that the total level of indebtedness was and is comparable to other developed countries.

The story that Rajan wants to tell is that:

the common thread was that debt-fueled growth was unsustainable.

Except, apparently, in Australia.  Australia ran a mildly higher inflation rate than the US during the “Great Moderation”, so its monetary policy was more “lax” than “easy money-easy credit” US.

Rajan is claiming that low interest rates are an “easy credit” policy: but credit is a supply-and-demand process. Yes, low interest rates make credit cheap to buy but it also reduces the return on providing it. Something is missing in this story; that a lot of capital was looking for safe havens. Many developing economies might be vigorously growing, but they have also been significantly failing to satisfy the demand for safer assets. Said demand therefore flowed into developed countries: including Australia, which continues to run the substantial current account deficits it has for 50 years (i.e. be a net importer of capital). So, the “too much debt/easy credit” story of sin Rajan (and others) want to tell just does not work if you include Australia.

It is true that Australian financial institutions were not much affected by the GFC and that Australian housing prices have not crashed (yet). The former is, in part, because of superior prudential regulation. This includes the Australian banking trade-off where the “four pillars” (NAB, Westpac, ANZ, CBA) have some level of protection in return for strong prudential oversight. Conversely, the American banking sector is far more fragmented, due to regulatory blocks on inter-state branching. Comparison with the performance of both the Canadian and the Australian banking sectors suggests that this regulated fragmentation has not been a social positive. (The much-discussed separation of investment and deposit banking is much less important.) But the GFC does not explain the Great Recession. On the contrary, a failure of monetary policy both aggravated the GFC and created the Great Recession; as was also true for the Great Depression [pdf].

So, despite “lax” monetary policy, fairly standard levels of indebtedness and a considerable export shock, Australian demand (and so income) did not collapse. Which meant debt remained manageable. Why?

The simple answer is: because our central bank is not mad (unlike other central banks). The RBA looks like a standard inflation-targeting central bank. Except it does not have a fixed inflation target, it has an explicit average-over-the-business-cycle target. Which means that, if output falls, the money supply does not have to follow output down. On the contrary, counteracting monetary stimulus “smooths out the bumps”. The effect is not merely to anchor price expectations, but to anchor income expectations as well. We did not end up in the situation where people are nervous about their income expectations but confident in their price expectations (i.e. the future-swap-value-of-money), which then encourages people to hold onto their money, which leads to less transactions and so less income (income being someone else’s spending; i.e. price x transactions), which increases concerns about income, leading to a downward spiral in transactions. Low interest rates are not a sign of “easy” money; they are generally a sign of “tight” money; of money being expected to retain—or even increase—its average swap values. (Inflation expectations in the US are currently very low while cash flow uncertainty can have, unsurprisingly, a significantly negative impact on corporate investment and employment.)

The RBA is also an example of the Australian ability to “do” bureaucracy. It has a clear policy focus, set out in a public letter of agreement between the Governor and the Treasurer, and a strong organisational identity that extends to deliberately investing in developing the skills and experience of its staff.

Rajan wants to tell a structural story for an economic downturn. Certainly, one understands the temptation of a crisis: “oh look, a crisis!, now I can get my favourite reforms through”. But that does not make it sound economics. On the contrary, there simply is no necessary trade-off between dealing with short-run level-of-economic-activity problems and fixing long-term structural problems. (And something that is clear enough to a high school student, however scarily smart, should probably be clear to a full professor.)

If income collapses, debt becomes much harder to manage. If your income does not collapse, you are much less likely to have a debt-management problem. Yes, lots of developed countries are having debt-management problems. But that is not because they were strikingly more indebted than Australia (even if their public debt levels are higher). It is because spending, and so income, did collapse.

Rajan’s penchant for false dichotomies does not just manifest in short-term/long-term trade-off claims, it also extends to excluding policy possibilities:

The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts that they will be saddled with.

Someone’s future liabilities are also someone else’s future income (which is why debt defaults worry folk so; yes, it eliminates someone’s liabilities but it also eliminates someone else’s assets: this also increases your risk premium for any future borrowing). But, leaving that aside, there can be spending without borrowing: that is the joy of monetary stimulus. Yes, the fiscal multiplier is a measure of central bank incompetence. Yes, the monetary authority “moves last”. But, if it is competent, it chooses to move in ways that do not create catastrophic collapses in spending and so income. If people have more confidence in their future income prospects, they will spend. And, if they spend, income goes up and debt becomes much more manageable.

Yes, it would be a good idea if developed countries reformed their public sectors, if they abolished regulations that protect incumbents and retard economic activity, if they got their debt levels under control. All things Australia has done (but, in some areas—notably its land use permit rajs—not enough). But neither the Great Recession nor the Global Financial Crisis would have been anywhere near as severe if the US, the UK and the Eurozone had had central banks as competent and accountable as the RBA. If they now became as competent and accountable as the RBA, economic recovery would occur much quicker and unemployment would fall much faster. The alleviation of utterly unnecessary human misery would be worth it all on its own. And structural reform could be sold as providing benefits, not simply sharing pain. Pain that, moreover, will not get folk spending again: for that, you have to change their expectations in positive ways. Which central banks can do more thoroughly, and far more cheaply, than anyone else. All it takes is to be as competent, and as accountable, as the RBA.

It is very, very necessary that folk start using the A-word, and considering the example it provides, a lot more.

61 Comments

  1. Posted May 6, 2012 at 10:07 am | Permalink

    Of course it helps that Australia’s Reserve Bank is publicly owned and accountable, whereas the USA Reserve is privately owned, with the sole aim of making the biggest profits possible for its owners.

  2. Tim Mulligan
    Posted May 6, 2012 at 11:08 am | Permalink

    The Austrian theory of the business cycle posits that government manipulation of the market price of capital (that is to say, government manipulation of interest rates) causes the business cycle. Full stop.

    On the other hand, much of what you say is Greek to me.

  3. Mel
    Posted May 6, 2012 at 11:26 am | Permalink

    Unfortunately the current federal government and most state governments are hell bent on getting balanced budgets, so unemployment will start risings and expectations will become more pessimistic.

  4. Posted May 6, 2012 at 11:44 am | Permalink

    Y@1 That does not explain the BoJ, the BoE or the ECB. Also, the President–with the advice and consent of the Senate–appoints the Chair and the Board of Governors. So, private ownership is not the key issue here.

    TM@2 The Austrian theory is wrong.

    M@3 No, that does not follow. Fiscal tightness, if anything, gives the RBA more room to move. Whether there should be more infrastructure investment is a different question (I would say yes).

  5. Tim Mulligan
    Posted May 6, 2012 at 11:56 am | Permalink

    By the way, thank you for a very thoughtful and helpful blog. I certainly hope that my country, the United States, will learn from Australia’s experience. I know that, in other areas like politics, Australia innovates in what I view as very helpful ways, such as weighted voting.

    It is quite possible that you are absolutely right, and that the Austrian theory of the business cycle is wrong. But after reading your blog about Austrian economics, I must quibble with your understanding of what the Austrian theory of the business cycle posits..

    The Austrian theory of the business cycle does not, to my limited knowledge, posit that a bust is caused by a preceding inflation. At least not if by “inflation” you mean a rise in prices. [In Human Action, Mises argued that inflation really means or ought to mean an expansion of the money supply. The two things are not necessarily coincident.]

    As I understand it, and in oversimplified form (i.e., the way a layperson like me would understand it), the Austrian theory of the business cycle goes something like this. A central bank puts interest rates at a level that is lower than *would* be prevailing in the market without a central bank. This leads to “easy money” or “comparatively easy money” or “easier money” (easy, again, compared to what lenders would charge in the absence of central-bank-influenced interest rates), and *not* necessarily a general rise in prices or high inflation.

    Easy money can exist withough high inflation (inflation meaning rising prices). Indeed easy money can exist even with zero inflation, or even with negative inflation (dropping prices). The United States over the past few years, for example, has had easy money (lots of monetizing debt), but not high inflation and obviously deflation in some prices. Easy money just means interest rates set by a central bank lower than what they would be if market rates were not influenced by a central bank.

    The artificially low interest rates give signals to borrowers that there’s lots of capital available. (In fact the artificially low interest rate overstates the availability of capital.) But the easy money cannot last forever. A bubble begins to rise and central bankers start to get worried that asset prices are inflated. So they begin to, as it were, ease up on the easy money (e.g., reduce their levels of monetizing debt). Bingo. The projects that were based on a given amount of information about available capital are no longer profitable, because, in fact, capital is not as available as the price of credit indicated. As soon as the slowing of easy money occurs, those projects that *looked* like they would be profitable, because of the appearance of more-widely available capital, now are revealed not to be profitable, because the reality of not-quite-so-widely-available capital comes to the fore. Those artificially created projects cease to go forward. The economy slows. Recession until the economy can manage to liquidate the artificially created projects, which takes time.

    And now that there’s a recession, politicians and yes central bankers too, want to get out of it. Guess how? You guessed it! Artificially lowering interest rates. The process begins anew.

    Boom and bust. Boom and bust. The one leads to the other in a never ending cycle.

  6. Posted May 6, 2012 at 12:42 pm | Permalink

    TM@5 That is a much better understanding of the Austrian theory than one normally meets on the interwebs. (Hence the hyperventilating about hyperinflation.) And yes, undershooting and overshooting interest rates could cause a boom-and-bust cycle. It is just that:
    (1) there is more to monetary policy than interest rates;
    (2) there are other causes of downturns. One can have boom and bust cycles without central banks. Or because central banks have money too tight, not too easy.

    The Austrian theory simply does not explain the severity of the Great Depression or the Great Recession. Though, central banks do not come well out of either, but for different reasons than the Austrian theory posits.

    Also, one of the reasons for the low interest rates of the Great Moderation was the flood of capital from the developing world into the US and other developed economies.

    To put it another way, Austrian theory should take supply and demand for money and supply and demand for capital a little more seriously.

  7. Tim Mulligan
    Posted May 6, 2012 at 12:56 pm | Permalink

    You have valid points. Economics are complex and other theories of economics, different from Austrian theories, have much to say.

    I agree that there are other factors at play, other than central bank actions. The Austrian theory of the business cycle, however, is not all there is to Austrian theory.

    I’m not sure it’s accurate to argue that Austrian theory does not take supply and demand for capital seriously enough. Isn’t that what the Austrian theory of the business cycle is about? Supply of capital versus the not-totally-accurate information that government-influenced interest rates give about supply of capital?

    Does the RBA monetize debt?

    I agree that easy money is not the only cause of downturns. As you mention, tight money can cause a downturn. That is a good point. But it’s consistent with the Austrian theory of the business cycle.

    This only proves the central Austrian point (in its theory of the business cycle): that government manipulation of interest rates (setting them higher than the market would do, OR setting them lower than the market would do) causes booms or busts or booms-and-busts. When actors invest and start projects based on not-totally-accurate information about how much capital really costs, these projects must eventually come to reckon with the true state of affairs about how much capital costs.

    I also agree that you can have booms and busts without central banks (without government manipulation of the price of capital). But this too is consistent with Austrian views. It’s the Austrians who most persuasively explain what caused the pre-central-bank business cycles (fractional reserve banking).

  8. Posted May 6, 2012 at 1:41 pm | Permalink

    TM@7 You can have booms and busts without fractional reserve banking too. (I’m a medievalist, history goes a long way back for me).

    Interest rates are the price of credit, not money. If one sets prices above or below the market clearing rate, one has consequences. But there are a lot of interest rates (and asset prices) apart from the bank/cash rate (or whatever rate the central bank is setting). The Austrian theory puts a whole lot of weight on one price in a web of credit/asset prices, all of which convey information.

    After all, if capital inflows were depressing long term interest rates, it is hard to argue that they were not conveying accurate information.

    And serious monetary tightening causing a bust is not particularly consistent with the Austrian theory: that is why Mises and Hayek got the Depression spectacularly wrong.

    Especially as interest rates were not what was doing the damage. (Thus my point about supply and demand for money, which is not a matter of interest rates: hence low interest rates can mean tight money.)

    There is a lot of information “noise” out there, hence businesses/project fail in booms too. The malinvestment theory seems to me to both over-simplify and have causality the wrong way around. It is not that misapplied projects cause the bust, it is that the lowered activity mean more projects become misapplied.

    Money can be held or spent. If people cut back on spending, that means money is tight (in terms of transactions and so income). But that also means there is more money potentially available for lending but fewer opportunities for it to be lent for: that clearly will drive the price of credit down. Especially as money can be expected to retain its value (it being scarce in transactional use), creating a low risk of loss of value (so low inflation premium).

    The Austrian story is so fixated on price that it does not give enough consideration to transactions.

  9. Tim Mulligan
    Posted May 6, 2012 at 2:51 pm | Permalink

    Interest is the price of capital. Capital usually takes the form of money. Your point is a distinction without a difference.

    Some of your examples, far from refuting Austrian theory, give examples of it or borrow from it. Others are unresponsive to anything I said.

    Respectfully, your comments suggest to me that you have an imperfect understanding of Austrian economic theory (e.g., monetary theory). Reading things on the internet is not enough. I recommend “The Austrian Theory of the Business Cycle and Other Essays.”

    Does the RBA monetize debt?

    I doubt very much that Mises and Hayek got the Depression “spectacularly wrong.” How much Mises have you read? What is the Misesian and Hayekian explanation of the Depression that you believe is “spectacularly wrong”?

    Your claims are numerous and quite ambitious.

  10. Tim Mulligan
    Posted May 6, 2012 at 3:04 pm | Permalink

    Supply and demand for money is condensed into interest rates. Interest rates are condensed information about how much capital there is, and how much demand there is for it.

    Low interest rates DO mean easy money, when made artificially lower by a central bank. That is a central point that I haven’t yet succeeded in getting across.

  11. Posted May 6, 2012 at 3:44 pm | Permalink

    It is to my considerable shame that this splendid piece (one that, to be fair, does not take sufficient account of Australia’s mini-permit raj when it comes to housing policy) had to be drawn to my attention by a member of the SNP over here. There are lots of things that Australia does spectacularly well:

    http://blogs.crikey.com.au/pollytics/2011/12/08/australian-exceptionalism/

  12. Mel
    Posted May 6, 2012 at 4:46 pm | Permalink

    Noah on Rajan’s rubbish.

    xx

  13. Posted May 6, 2012 at 7:13 pm | Permalink

    Good find, Mel. Thanks.

  14. Posted May 6, 2012 at 7:54 pm | Permalink

    TM@9

    Interest is the price of capital. Capital usually takes the form of money. Your point is a distinction without a difference.

    Interest is the price of credit: capital is not necessarily acquired in the form of credit. It will, however, be connected to other asset prices. It is not the price of money.

    The nominal price of money is 1 (since money sets nominal prices). The “real” price of money (money in terms of goods and services) is what you can buy with it. If prices of goods and services go up, the price (or, as I prefer to say, the swap value[s]) of money goes down. If the prices of goods and services go down, the price/swap values of money increases. It is an inverse relationship. So, inflation means money is losing value, deflation that it is gaining it.

    Interest rates include expectations about the future value of money (aka expected inflation/deflation). Clearly, something that includes the expected future price of something cannot be the price of that thing.

    But this also means that low interest rates can be a sign of “tight” money, since it indicates that people expect money to retain (or even gain) value.

    A good post on the weakness of Mises and Hayek on the Depression is here.

    TM@10 What you want to say is that the central bank is artificially depressing information about risk. So people invest more in projects than their actual risk levels warrant. My point is that:
    (1) information about risk is richer than the base interest rate as set by the central bank
    (2) there is more to monetary policy than interest rates.

    Low interest rates are NOT indicators of easy money. They do indicate credit is cheap, which is not the same thing.

  15. Posted May 6, 2012 at 7:55 pm | Permalink

    TM@9 On whether the RBA is monetizing debt, not so you would notice.

  16. Tim Mulligan
    Posted May 6, 2012 at 9:04 pm | Permalink

    Thank you for your thoughts. Interesting and very worthwhile conversation.

    Unfortunately I do not have time to go to links. I am willing to read this blog but I choose not to go to further links. I ask for your understanding of the Misesian and Hayekian understanding of the Depression that is “spectacularly wrong.” I am not sure I know what it is but I am skeptical that it is “spectacularly” wrong. Frankly, I didn’t know that Mises and Hayek had the same explanation of the Depression.

    Without time to go to links, I ask whether the RBA monetizes debt. Respectfully, it’s a yes or no question.

    You say low interest rates are not indicators of easy money. I did not say they are they are. You have successfully destroyed that straw man. Easy money is when interest rates are artificially reduced, by a central bank, lowER than what they would be in a free market. High interest rates are still easy money when they’re lowER than what they would be without a central bank.

    By the very same token, you are correct that low interest rates may be tight money. When market interest rates would be highER than those influenced by a central bank, then yes, low interest rates are tight money. You have successfully (and unwittingly) supported Austrian monetary theory.

    You argue that low interest rates indicate that credit is cheap. I agree. But that argument is pretty basic, and tautological or at least just an expression of the same thing in slightly different words.

    Central banks do not have just one interest rate. At least not in the U.S. You cannot possibly refute the fact that central banks influence interest rates.

    For the record I agree with you and skepticlawer that Australia does lots of things right. I just want to iterate that there is much to learn, here in the U.S., from Australia, economically. [And otherwise. Off topic, Mr. Glaezer makes the best Shiraz known to man.] I am not criticizing your argument about Australia, only your arguments that (1) I mischaracterize the Austrian theory of the business cycle; (2) that Austrian theory is “wrong” simpliciter. It may not always be predictive (although I think it isually is) and certainly does not explain every and all aspects of actual business cycles. But that does not make it wrong.

    What I disagree with is your breathtakingly ambitious criticism of Austrian theory, especially Austrian monetary theory.

    Respectfully, you are still making distinctions without differences about interest rates being the price of capital. Interest rates are the price of borrowing. Full stop. Prices, including the price of credit, are usually expressed in money so your argument that the price of money is expressed in goods is a failing attempt to quibble with an argument that you are safe to accept.

    What I want to say is that central banks manipulate interest rates. It’s really quite simple when you think about it. Respectfully, do not tell me what I want to say. I have explained the Austrian theory of the business cycle accurately. If you have any way to try to refute it (you claimed from the very beginning that it is plain “wrong”), try. But so far you have said nothing that refutes Austrian theory. Respectfully, you continue to just make effortful distinctions, and to make arguments that in no way refute (1) what I have said; or (2) Austrian theory. Some of the observations you make may be accurate or true. But what about the Austrian theory of the business cycle is “wrong”?

    I agree that there is more to “monetary policy” (what we’re really talking about is monetary theory) than interest rates. But I think the conciseness and elegance of the Austrian theory of the business cycle are strong. (Sort of like the conciseness and elegance of John Rawls’s theory of justice. And now that I think of it, your taking on Mises, Hayek and Austrian monetary theory is a bit like me taking on Rawls.) Respectfully, in my judgment you haven’t made progress in refuting it.

  17. kvd
    Posted May 7, 2012 at 4:49 am | Permalink

    Son, we live in a world that has theories. And those theories have to be guarded by economists with blogs. Who’s gonna do it? You, Tim? You, Mel?

    I have a greater responsibility than you can possibly fathom. You weep for Hayek and you curse the Central Bank. You have that luxury. You have the luxury of not knowing what I know: that Hayek’s death, while tragic, probably saved interest. And my existence, while grotesque and incomprehensible to you, saves interest. You want the Truth? You can’t handle the Truth. Because deep down, in places you don’t talk about at parties, you want me on that theory. You need me on that theory.

    We use words like “interest”, “monetary”, “capital”…we use these words as the backbone to a life spent defending something. You use ‘em as a punchline.

    I have neither the time nor the inclination to explain myself to someone who rises and sleeps under the blanket of the economic theory I provide, then questions the manner in which I provide it! I’d rather you just said thank you and went on your way.

    Aaah, Mondays… ;)

  18. Posted May 7, 2012 at 5:26 am | Permalink

    kvd: You’re a bad man.

    TM@16 Neither of the links is particularly long and they answer your questions: the link on Mises and Hayek on the Depression better than I could. (Mises and Hayek had much the same view of the Depression at the time, Hayek changed his mind later. Their “liquidationist” policy of sticking with the gold standard come what may was precisely the opposite of what was needed.)

    The RBA could monetize debt and I presume it has at some stage, but not recently as far as I am aware. If you went to the link you could see what happens to the monetary base when central banks run tight money policies. (The monetary base surges: credit is cheap but money is tight.)

    If we could agree that interest rates are the price of credit (not money), and that is a distinction that matters, that would be fine.

    Central banks normally set only one (short-term) interest rate. It is true that other interest rates take their “cue” from it, but it is also true that long-term interest rates shift according to market expectations.

    Can the Austrian theory say something useful about economic cycles? Yes. Is it a good explanation of the entire boom-and-bust patterns we observe? No.

    For a start, central banks can err in both directions, not just one. (This is presumably why George Selgin–Mr Free Banking–I am told no longer regards himself as an Austrian.)

    If you want to define “easy” or “tight” in terms of some policy objective, you would be in excellent company (Scott Sumner most notably).

    Yes, there is always an argument about whether interest rates (and specifically the base rate the central bank sets) should be higher or lower. Such interest rates both set a minimum price for credit and indicate the future stance of monetary policy. (One of the reasons the RBA is so effective is that its policy objective is explicit, making managing nominal expectations much easier.) Determining what the “free banking” level of interest rates would be in order to assess actual interest rates is a fascinating exercise: good luck with that.

    However, the base interest rate (or even interest rates in general) is not the question about which the entire boom and bust cycle turns, so Austrian business cycle theory is wrong.

  19. kvd
    Posted May 7, 2012 at 6:41 am | Permalink

    Why thank you Lorenzo@18 – I try to maintain a sense of the ridiculous whenever two economic theories collide. (Perhaps the IP lawyers here could tell me if my blatant plagiarising of an earlier plagiarism constitutes a breach of original copyright?) ;)

    I do have a couple of personal queries to put to you, but I think I’ll wait till your ‘conversation’ plays out so as not to distract.

    Tim@16 your “I think the conciseness and elegance of the Austrian theory of the business cycle are strong” is a little difficult to refute if you do not wish to peruse the (very) many talented commentaries available on the web which do precisely that.

    What follows is a cut and paste from this economist – you may know of his “Zombie Economics” book, for instance? Anyway, the link is worth a full read, but briefly:

    To sum up, although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas. The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma.

    Now as to theories generally – on whatever subject – they not only have to be ‘concise and elegant’ they also have to reflect both past and future realities. E=Mc2 is one such; Austrian Business Cycle Theory, less so, and I took Lorenzo to be saying something like that.

  20. Tim Mulligan
    Posted May 7, 2012 at 7:49 am | Permalink

    Thank you for your thoughts. I greatly appreciate pithy arguments like yours. Few have the gift of conveying arguments concisely.

    Instead of our tendency, yours and mine, to jump from one issue to another, let’s try to focus for a moment. One of my first efforts here is that I have tried to set forth, in simplified form, what Austrian monetary theory says (before arguing that it is true, percipient, or predictive). You argue, ambitiously, that it’s “wrong,” but, as far as I can tell, do not address whether I have described it reasonably accurately (which was, I believe, our first quibble). Can we stick with that point for a moment? Have I accurately described the core points of the Austrian theory of the business cycle, as far as you understand it?

    You argue that long-term interest rates shift according to market expectations. I agree. Does this argument refute Austrian monetary theory?

    My how we love to set up, and then destroy, straw men. I did not argue that Austrians wish to make an effort at “Determining what the ‘free banking’ level of interest rates would be in order to assess actual interest rates . . . .” You’ve got Austrian monetary theory wrong. Austrians generally do *not* try to set central bank interest rates at rates that would prevail without a central bank. That is exactly what Austrians want to eliminate! You’re making a fundamental error. Austrain theory of the business cycle is empirical, not normative. It explains and predicts business cycles. You think Austrian business cycle theory is saying “the central bank should set interest rates at market rates.” It’s not saying that. It’s saying “central bank manipulation of interest rates causes or at least contributes to business cycles.”

    You argue that interest is the price of credit but not of money. I still don’t understand the distinction. Once again, it’s a distinction without a difference. Try borrowing money. You will pay a price. And that price we call interest. You’re a medievalist. I recommend The Merchant of Venice. Focus on the words of Shylock, the lender. (While the play is not usually set precisely in medieval times, it is about a time in which Gentiles still opposed the charging of interest.)

    You argue that central banks can err in both directions, apparently believing that this is a criticism of Austrian monetary theory. I, myself, already made this very argument. Your effort to refute Austrian monetary theory is not going well.

    I want to know your arguments. I choose not to go to links because I assume that, by posting a link, you are unable or unwilling to make the argument yourself. I am testing *your* arguments, not those of another writer. It already takes me enough time to respond to yours, although I am grateful for the intelligent and stimulating conversation.

  21. kvd
    Posted May 7, 2012 at 8:04 am | Permalink

    Oh well. There goes what could have been an interesting discussion.

  22. Tim Mulligan
    Posted May 7, 2012 at 8:29 am | Permalink

    KVD, thank you for your thoughts.

    If other writers have, as you claim, refuted the Austrian theory of the business cycle, well and good. Lorenzo hasn’t.

    For the time being, I choose not to read the article in The Economist. Summarize it please. The quote you take from it is a far cry from refuting the Austrian theory of the business cycle. If the article is anything like the quote, it merely nibbles on the heels of the Austrian theory, which is a theory of monumental significance in the history of economic thought.

    I agree that my sentence that you quote (that the conciseness and elegance of the Austrian business cycle theory are strong) is hard to refute if you don’t read the internet articles that (in your opinion) refute it.

    The more modest writers (and I recommend that you don’t believe everything you read on the internet) acknowledge the conciseness and elegance of the Austrian theory. There’s a difference between (1) being accurate, true, and predictive; and (2) being concise and elegant. Read Robert Nozick’s Anarchy, State and Utopia. In it, he acnowledges the breathtaking conciseness and elegance of John Rawls’s theory of justice, but then goes on to attempt to refute Rawls’s theory (using, as it happens, the ideas of an Austrian economist, Murray Rothbard).

  23. Tim Mulligan
    Posted May 7, 2012 at 8:32 am | Permalink

    Oops. I said The Economist, as in the magazine. I should have said “the book.”

  24. kvd
    Posted May 7, 2012 at 8:45 am | Permalink

    Sorry Tim. Life is too short to engage further in meaningless back and forth such as you seem to wish. Links from posts, to my mind, serve to both expand upon the concepts being discussed, and to acknowledge others’ well thought through positions – but without detracting from the main message of the post itself.

    I took this post to be a musing upon why it is that Australia (the A-word) is not more widely referenced by governments and economists seeking to address the problems we all face. That it has degenerated into an arcane discussion of the meaning of ‘interest’ etc. is both a disappointment and a loss for my own education.

    ADMIN – I hope that is civil enough?

  25. Mel
    Posted May 7, 2012 at 8:56 am | Permalink

    Wow. I had no idea before entering the blogosphere that the world is full of born again Austrians.

    Tim Mulligan, most people have lives to live and spending hours arguing with Austrians is an unfructuous intrusion into life, liberty and the pursuit of happiness. I think Lorenzo has already shown incredible good grace and patience.

  26. Tim Mulligan
    Posted May 7, 2012 at 9:54 am | Permalink

    Skepticlawyer and legal eagle, have I been out of line in my arguments?

    If I have violated any policy, I apologize.

    If I have been uncharitable in my posts, I apologize. It was not my intent to do so.

    If I have frustrated you, I’m sorry. It was not my intent to frustrate anyone. Truthfully, I think both sides here are frustrated. Let’s both sides chalk it up to disagreeing, and not accuse the other side of wrongdoing.

    Lorenzo is not the only one who has bent over backwards to be patient. It is I, really, who have shown incredible good grace and patience. I think you guys need to read my remarks in a more friendly light, and not view me as some sort of enemy just because I disagree. I feel like there’s some groupthink going on here.

    I feel like I’m being cast as the bad guy here, when, at least from my perspective, I was merely standing up, in a reasonable manner but also in a cogent and direct manner, for what are a very defensible positions. I tried to be as polite as possible. If I was impolite or uncivil, I apologize sincerely. I do think, forgive me, that in this instance, dissent, and not the tone or tenor of the remarks, has caused frustration. I feel it’s unfair to cast me as a bad guy in this conversation.

    Lorenzo, do you feel I treated you unfairly?

    I ask for patience and tolerance in response to dissenting remarks even if they are expressed with firmness and consistency. You are entitled to them and so am I. It is my full and sincere intent to show patience and tolerance for every single remark of every other person. I have made every effort to treat others respectfully and will continue to do so. Candidly, I do not think any of my remarks were disrespectful.

    KVD, I feel like you are imperfect in your tolerance for my dissenting remarks. Please be patient with me when I disagree with you and others.

    Mel, I feel like you, too, are showing some intolerance for my remarks. Please be patient when I disagree with you and others.

    I feel like the two of you are showing bias in favor of the person (1) with whom you agree; and (2) with whom you are a fellow blogger on this site.

    Respectfully submitted,
    Tim Mulligan.

  27. Bazz
    Posted May 7, 2012 at 11:00 am | Permalink

    Oh dear, will they never learn ?

    Growth and the economy in general do not depend on money or the various manipulations of it.

    It is energy that enables growth, not money or credit etc etc.
    It all fell apart when oil reached $147 a barrel. Oil is now more than five times more expensive than it was 10 years ago.

    Wake up !

  28. Posted May 7, 2012 at 11:35 am | Permalink

    Dear all,

    I have 2 exams in the next 72 hours, and am not in the position to do much blog-wrangling. Please play nicely :)

  29. Posted May 7, 2012 at 12:00 pm | Permalink

    Fiscal tightness, if anything, gives the RBA more room to move.

    How so? What does fiscal tightness allow the central bank to do that it could not otherwise do? Has Australia helped the RBC with fiscal tightness, and if not can you point to any countries that have demonstrated its benefits in this situation?

    Here in the US the main constraint on the Fed is that interest rates are extraordinarily low, so extraordinary action would be required to push them lower. Fiscal expansion could push interest rates up, giving the Fed more room to act.

  30. Patrick
    Posted May 7, 2012 at 12:49 pm | Permalink

    Despite the fact that mel probably thinks I am an Austrian, I don’t care less about Austrian economics or whatever it is, or even about Austria.

    But I can tell you why Australia is not seen as a great example by everyone else!

    1) We’re not them. How often do you see, outside of esoteric blog commentary and lefty whinging, references to other countries’ policy examples in Australian policy discourse? This takes care of 70%.
    2) The other 30% is that we really really aren’t them. The difference in the path’s we’ve travelled is so great that for most Southern European countries, for example, it would be like a struggling handball player wondering how to be more like Billy Slater. For the less-fucked countries it would be like a champion pole vaulter wondering if they could learn from a union prop’s training regime.

    Less floridly, think about it for a sec: from far away we must look a lot like Norway does to us – a nice example of what you might do if you were Norwegian.

  31. kvd
    Posted May 7, 2012 at 1:04 pm | Permalink

    LE@27 my apologies for my lack of understanding that when Lorenzo posts about Australia, the RBA, the four pillars, drop bears and funnel webs he is in fact using some sort of weird economic code for the real topic: Austria ;)

    Tim@26 I am not especially intolerant of your remarks (some of which I agree with), just more wishing they were in some way related to the subject of the post.

    In the meantime Australia actually is another country, and I’m just sorry that Lorenzo’s proposition as to its possible significance as a model has not been even remotely addressed.

  32. Posted May 7, 2012 at 1:44 pm | Permalink

    B@28 Except that Australia has to deal with the cost of oil like everyone else, and we managed. The problem with making it all about oil, is then all oil importing countries should have the same experience, and they do not. On the contrary, we can see similar problems in an oil exporting country (the UK) as in oil importers (the Eurozone, the UK and Japan) and not in any correlation to their level of imports.

    EL@30 If the government is not pumping spending into the economy by deficit financing, the central bank does not have to worry about inflationary pressures from that. Hence, a more fiscally austere stance allows the central bank to be looser in monetary policy (which is a much cheaper and more efficient way to keep spending, and thus incomes, up).

  33. Posted May 7, 2012 at 1:46 pm | Permalink

    P@31 Yes, but serious professors of finance, and other economists, should be able to consider all the relevant cases before spouting off.

  34. Posted May 7, 2012 at 1:51 pm | Permalink

    TM@26 While you have shown far more good grace than many an online Austrian does, this is becoming the same sort of experience I and so many others have had debating with Austrian commentators. Nothing ever seems to “stick”. Arguments get ignored, all sorts of restrictions about what counts as evidence are imposed, the position being defended seems to shift every time its prodded. It becomes a dialogue of the deaf.

  35. Posted May 7, 2012 at 2:25 pm | Permalink

    TM@20

    You argue that long-term interest rates shift according to market expectations. I agree. Does this argument refute Austrian monetary theory?

    My point is that the web of interest rates (and asset prices) makes the central bank setting the base interest rate sufficiently less important as to make Austrian claims about its importance less plausible.

    You think Austrian business cycle theory is saying “the central bank should set interest rates at market rates.” It’s not saying that. It’s saying “central bank manipulation of interest rates causes or at least contributes to business cycles.”

    If the central bank is setting it at what would be the free banking market rates, then it is not manipulating the interest rate. It is divergence from the “free bank” interest rate which counts as manipulation; otherwise the term has no meaning.

    You argue that interest is the price of credit but not of money. I still don’t understand the distinction. Once again, it’s a distinction without a difference. Try borrowing money. You will pay a price. And that price we call interest.

    The difference between money and credit is so basic, it is hard to get anywhere without grasping the distinction.

    If there was no credit, money would still have a price. That would be, like all prices, what you can get for it, its “swap value”.

    Conversely, if you borrowed cows, for a consideration, that would be credit and it would have a price, but there would be no money. A barter economy can still have credit (and even a form of interest rates, if the fee for borrowing the cows adjusted for the length of time of the borrowing).

    The price of credit in a money economy involves:
    (1) “the risk free cost of capital”;
    (2) the risk involved in the particular borrowing;
    (3) the risk involved in the expected shift in the value (i.e. “price”) of money.

    The price of credit (interest rates) thus incorporates the expected path of the price(s) of money. So interest rates are the price of credit, not money.

    You argue that central banks can err in both directions, apparently believing that this is a criticism of Austrian monetary theory.

    It is when the typical form of the Austrian argument is that the bust is the result of the previous underpricing of credit when and if a bust is the result of the central bank following a tight money policy. As was the case with the Depression and the Great Recession.

    I want to know your arguments. I choose not to go to links because I assume that, by posting a link, you are unable or unwilling to make the argument yourself. I am testing *your* arguments, not those of another writer.

    I am not your student and you are not my teacher, this is not a grading exercise. I did not come up with all this on my own, it comes from reading many other writers and bloggers, many of whom are far more knowledgeable about this than I. So of course I am going to reference people more knowledgeable than myself, because this is not an exercise in personal display, it is an argument about what is the case.

    Links are the internet version of footnotes, except cooler. Like footnotes, they allow people to see where things come from, what is being cited, and what evidence is being used. If you don’t “get” links, you don’t get one of the things that is great about the internet (and blogging).

  36. Postkey
    Posted May 7, 2012 at 6:09 pm | Permalink

    Hello,

    You may not have seen this?
    “The correct answer to the crisis was either for central banks to clarify that, with full government support, they would lend without limit to solvent banks (and charge a high interest rate) or for government to extend a blanket guarantee on the liabilities of any bank asking for one (and demand an expensive guarantee fee). The inter-bank market could then have reopened. That would have stopped the tens of millions of job losses and trillions of output foregone. Tidying up the financial system thereafter might have taken five to ten years, but the macroeconomic disaster of 2009 could have been avoided. In only one advanced country, Australia, did officialdom see clearly what had to be done when it introduced a general deposit guarantee in October 2008. Uniquely it has not had a recession.”

    http://www.spectator.co.uk/books/5749198/part_3/bankbashing-with-a-vengeance.thtml

  37. Posted May 7, 2012 at 6:48 pm | Permalink

    Okay, anti-econo-girl is very confused at this point. Like Tim, I’m having difficulty understanding your point about the difference between the price of credit and the price of money, Lorenzo (due to ignorance on my part, I’m sure).

    Traditionally, credit is possible because there is unused capital accumulated by savers that is available to rent at interest and the interest rate is colloquially referred to as the “price of money” (as opposed to the direct exchange value of any precious metals contained in the physical artefact). In a pre-industrial market you wouldn’t ‘borrow’ a cow, you would rent it for a period, and there are rules in either statute or the individual contract to determine the ownership of any resultant offspring or liabilities for damage.

    In the modern economy credit can be extended on debt – sorry, there’s got to be a better way of putting it, that sounds awful – either in the form of debt instruments (eg. bonds) issued by central banks /Treasuries or the extra multiplier of fractional reserve rules that permit authorised lenders like retail banks to lend out more than they actually hold in capital assets (deposits). The interest rate will be effected by so many different variables it is almost impossible to predict (how reliable is the lender, how reliable is the borrower, is there a glut of lenders or borrowers etc.) and the only thing that makes it even seem possible is the fact that these agreements or contracts are always TIME LIMITED.

    Central banks attempt to manipulate this hugely complex market in credit by a) setting a central interest rate they’re willing to accept on their own debt – in attempts to increase or decrease overall market activity – or in extremis b) creating more credit instruments – such as the British programs of quantitative easing, aka printing-more-money. Presumably governments could also sell off assets or use physical reserves to buy back their debt instruments and reduce the supply, but few seem to do this.

    I’m not sure what the RBA specifically is up to but I have been following the Bank of England/Treasury attempts to mess with this market, and frankly it’s quite terrifying. Both QE and interest rates seem very blunt instruments for guiding a market that may not actually agree to be guided. QE was brought in over here because LIBOR/the short-term lending market between banks totally collapsed because it became impossible to factor-in the outstanding liabilities of either borrowers or lenders and market confidence dropped. The Treasury dumped extra credit into the system to try and jump-start the market, but initially this didn’t work and there are still worries that though activity has restarted, the problems have only been postponed until the end of the time-limited contracts.

    The problem with any of the economic theories is that they assume that the manipulation of interest rates or even supply of money, can actually control the market, whereas all it really seems to do is influence market sentiment. And as such, how much credit can or should then be taken for national economic policies? (Like they say about advertising, there’s clear evidence that 50% of your output will work but it’s impossible to determine which 50%!)

    Everyone is now free to call me an idiot.

  38. Posted May 7, 2012 at 7:25 pm | Permalink

    I don’t want to buy into some of the discussion here, but a few general points.

    Australia has a reasonable public service still concerned about performance. We have an usually high degree of economic literacy in the general population and indeed interest in public policy by global standards,

    Despite our complaints about our pollies, they are actually not bad by global standards.

    We have a robust climate of debate.

    We are also pragmatic, interested in what works, suspicious of ideology whether of left or right. And, nothwithstanding some recent trends, we don’t take ourselves too seriously.

    I say all this despite my constant campaigns for reform. We knock ourselves and don’t recognise our achievements, but that’s not necessarily a bad thing.

    And we have been bloody lucky to have a small population in a big country with lost of minerals or, before that, primary products that people wanted to buy.

  39. Posted May 7, 2012 at 7:31 pm | Permalink

    Pkey@37 The “credit channel” argument for what went wrong. Not convinced:
    (1) Australia did not have much of a financial crisis problem in the first place.
    (2) We also dealt with a considerable export shock. Sure, the exchange rate took the hit, as it was supposed to, but the RBA also ran a looser monetary policy.
    (3) Meanwhile, the Fed was surreptitiously disinflating, which made the financial crisis worse. The ECB has been running a tight monetary policy which drove spending (and so incomes) down in the Eurozone. The BoE has wobbled all over the joint.

    I agree that Oz officialdom acted effectively, but I would give more causal importance to monetary policy.

    DEM@38 If you want to take interest rates as the price of renting money, that’s ok. But it is not the price of money. Just as the price of renting a house is not the price of a house and the price of renting a cow is not the price of a cow.

    As for the BoE’s shenanigans, that’s what happens when you fail to manage expectations effectively. This post provides some revealing comparisons.

    There are two problems: not having an explicit target (the Fed, the BoJ) so folk infer from your actions. Having an explicit target that’s the wrong one (the ECB and the BoE).

    The RBA has an explicit target that is the right one (or a right one).

    And no, your questions are perfectly reasonable, you are not an idiot :)

  40. Posted May 7, 2012 at 7:36 pm | Permalink

    JB@39 I agree. Though countries with plenty of resources have also screwed up spectacularly. Hence the argument over the resource curse. So perhaps we should give ourselves more credit there too.

  41. Posted May 7, 2012 at 7:42 pm | Permalink

    kvd@19 Thanks for that link, Quiggin’s discussion of the history of Austrian economics is excellent.

  42. Posted May 7, 2012 at 8:39 pm | Permalink

    I think Jim’s points @39 are very salient. I do sometimes wonder at the extent to which they are connected to compulsory voting: you don’t get to implement ideological silliness in Australia, as most people are uninterested in politics and will punish you if it (ie, your grand politically inspired scheme) doesn’t work.

  43. Posted May 7, 2012 at 8:54 pm | Permalink

    SL@43 Also preferential voting. People can vote as they feel, they don’t have to angst over trade-offs between who they like and who might have a chance. It gives voters more genuine say and makes votes more informative.

  44. Postkey
    Posted May 7, 2012 at 10:47 pm | Permalink

    Hi Lorenzo,

    I think the economist who wrote the above would agree with you re monetary policy?

    “The debate about quantitative easing, and the larger debate between creditism and monetarism to which it is related, will rage for the rest of 2009 and probably for many years to come. Much will depend on events and personalities, as well as on ideas and journal articles. But there is at least an argument that Bernanke’s creditism was the mistaken theory which, by a remorseless logic of citation, repetition and emulation, spread around the world’s universities, think tanks, finance ministries and central banks, and led to the Bedlam of late 2008. The monetary approach — which Bernanke himself saw as standard and traditional — argued that measures such as quantitative easing, rather than bank recapitalisation, were appropriate in September and October last year. Why were large-scale expansionary open market operations — operations targeted directly to increase bank deposits — not adopted at that stage? And would not hundreds of thousands of jobs, and thousands of businesses, have been saved if the Treasury and the Bank of England had bought back vast quantities of gilts then instead of bullying the banks? (This is not to propose that the banks are perfect and angelic. They had been silly, naughty and greedy in the years leading up to the crisis of 2008. But they tend to be silly, naughty and greedy in the years leading up to most crises, and recessions as severe as the current one are not normally visited on innocent bystanders.) 
    The academic prestige attached to the “lending-determines-spending” doctrine and other credit-based macroeconomic theories is puzzling. As noted earlier, Bernanke and Gertler included in their 1995 article an observation that comparison of actual credit magnitudes with macroeconomic variables was not a valid test of their theory. One has to wonder why. They claimed that bank lending was determined within the economy and so was “not a primitive driving force”. (In jargon, bank lending was endogenous and determined by the economy, not exogenous.) Bernanke and Gertler must have known that the relationships between credit flows and other macroeconomic variables were weak or non-existent, casting doubt on their whole approach.
    In the event, their reservations about the predictive power of credit aggregates were neither here nor there. In late 2008 policy-makers were bossy and crude in their demands that the banks lend more and have enough capital to support the new loans.  More bank lending was deemed to be good, without ifs or buts. To repeat Darling’s words, “We have got to recapitalise first. You’ve got to get the expansion of lending.” Bluntly, the statistics justify neither official policy nor Darling’s hectoring and aggressive tone, while Brown’s claims to be “rescuing the world” have come to look ridiculous. In no economy are there reliable relationships between bank lending to a particular sector and activity in that sector or the wider economy. In that sense the bank recapitalisation exercises were sold on a false prospectus. 
    Another enigma here is that the alternative view — that in the long run, national income is a function of the quantity of money — has clear and overwhelming substantiating evidence from all economies at all times. Both evidence and standard theory argue that the expansionary open market operations that are the hallmark of quantitative easing, not bank recapitalisation, should have been policy-makers’ first priority last autumn. In the next crisis they must accept that money, not bank credit by itself, is the variable, which matters most to macroeconomic outcomes.”
    http://standpointmag.co.uk/node/1577

  45. Posted May 7, 2012 at 11:36 pm | Permalink

    Pkey@45 Basically, yes. Scott Sumner respects his efforts, and that is good enough for me.

  46. kvd
    Posted May 8, 2012 at 2:41 am | Permalink

    Lorenzo, regarding your thought that Australia might be some sort of worthwhile model for the world? Consider the following;

    a) The RBA is provided with Bureau of Stats data only quarterly, yet makes its decisions monthly. Put simply they “fly blind” two months in three.
    b) Westpac (for example) applies the full 0.5 downward decision to 7-800,000 depositors, but only 0.35 to its 150,000 borrowers, and ANZ doesn’t even meet till the next week. This is basically the RBA giving the four pillocks a licence to print (more) money. But I’m wrong of course; that is done by e) below.
    c) Australian trading in securities is overseeen by a public company ASX, which itself is listed on its own exchange – subject, I guess, to some sort of honour system, in order to avoid any suggestion of conflict of interest.
    d) ASIC, the “moderator” of corporate behaviour (including the ASX) would seem to have difficulty regulating your normal church cake stall. See various High Court losses.
    e) The RBA’s own trading subsidiary – Note Printing Australia – seems to play fast and loose. Google that name plus ‘bribery’. The first reference I got was to ASIC not pursuing the RBA – hence d) above.
    f) Investment decisions are made by our largest companies – for example the Northwest Gas Shelf and Olympic Dam decisions – after decade-long planning and evaluation processes, and involve decades long production cycles. The RBA flicking interest up or down by .25 or .5 every few months would seem of little consequence to this process, yet economists speak of “malinvestments” directly related to the price of credit.

    I suppose I should ask the members of the RBA board about this last point? They seem well represented on many of the boards of the very economic entities their decisions are meant to influence.

    I guess my query to you is: which bit of what “we do good” would you suggest as a worthwhile model?

  47. Posted May 8, 2012 at 11:09 am | Permalink

    If the government is not pumping spending into the economy by deficit financing, the central bank does not have to worry about inflationary pressures from that. Hence, a more fiscally austere stance allows the central bank to be looser in monetary policy (which is a much cheaper and more efficient way to keep spending, and thus incomes, up).

    What you are suggesting sounds to me more like “Fiscal tightness will give the central bank the political will to act” rather than “Fiscal tightness will give them the ability to act.” If the Fed fears inflation, they raise interest rates. If that kills demand, the inflation won’t materialize and they’ll lower them again. And they’ll actually be able to lower them.

    Maybe this is a difference of continents; you say there is no financial crisis in Australia, so maybe your situation is different but coming from the U.S. it floored me to read that we need looser credit, that that is always the best way forward no matter how loose credit has gotten already.

    For decades, with each recession here the Fed has needed to lower rates to a lower level than it needed to in the previous recession to reinvigorate the economy. It seems to be an article of faith among monetarists that this can continue forever; that the success of monetarism in times of higher rates proves it is the only thing ever necessary and the world is just suffering from a sudden wave of incompetence among almost all the central banks; that inflation is the only bad thing that can result from too loose credit.

    The Fed has not gotten more effective at fighting recessions as credit has gotten looser. What country has demonstrated the usefulness of fiscal austerity in a recession?

  48. Posted May 8, 2012 at 2:03 pm | Permalink

    EL@48 Who said anything about looser credit? I know folk talk about monetary policy in terms of interest rates, but there is more to monetary policy than interest rates.

    Interest rates are higher in Australia than the US. Have a look here, the figures and analysis is very revealing.

    Also, there is reason to believe that interest rates are in long-term decline, particularly in the US, since it has remained such a preferred safe haven for capital from the developing world (which is getting more prosperous, so producing more savings and thus more capital). I would not hold the Fed solely responsible.

    What you are suggesting sounds to me more like “Fiscal tightness will give the central bank the political will to act” rather than “Fiscal tightness will give them the ability to act.”

    Yes, if you like. The RBA has a known policy objective, so in our case it is a distinction without much difference.

    If the Fed fears inflation, they raise interest rates. If that kills demand, the inflation won’t materialize and they’ll lower them again. And they’ll actually be able to lower them

    Yes, the monetary authority moves last. So, the US gets as much stimulus as the Fed is happy with. That is why changing the policy objective and expectations management of the Fed is so important.

  49. Posted May 8, 2012 at 2:12 pm | Permalink

    kvd@47 Much of your list has little or nothing to do with monetary policy. But, to tackle them

    (a) Not the RBA’s fault, and makes one wonder how useful the CPI stats are. I am reminded of a Chief Secretary of Hong Kong who deliberately blocked the collection of statistics, on the grounds it would only encourage government to act.

    (b) There are trade-offs with the four pillars policy. But I would prefer sound and profitable major banks to the alternative.

    (c) Nothing to do with the RBA and monetary policy. Also, remember my praise is comparative, not absolute.

    (d) Corporate regulation always has a comparative talent problem (more money to be had in gaming the regulations than enforcing them). Still, we do not seem to have quite the egregious level of failure that the US, Japan and similar have experienced. Also, nothing to do with monetary policy.

    (e) Nothing to do with monetary policy. I would note there is a persistent tendency for public sector institutions to have less regulatory oversight than private companies.

    (f) Quite. But, as i had said above and elsewhere, I really dislike the notion of ‘malinvestment’.

  50. kvd
    Posted May 8, 2012 at 2:45 pm | Permalink

    L@50, I did appreciate my questions were not directed to monetary policy, however I think it needs to be accepted that whatever policy alternatives are pursued, they will exist within and must have regard to the prevailing institutional and regulatory framework. Elegant theory eventually has to deal with gritty reality for it to be of any relevance.

    That said, thanks for acknowledging and addressing my points; your comments are interesting.

  51. Posted May 8, 2012 at 6:19 pm | Permalink

    Sorry, anti-econo-girl again.

    DEM@38 If you want to take interest rates as the price of renting money, that’s ok. But it is not the price of money. Just as the price of renting a house is not the price of a house and the price of renting a cow is not the price of a cow.

    So are you talking about the house/cow as having an inherent value as in an ‘assumed value’ if you wanted to use it as security for borrowing? I thought the basic economic principle was that things have no inherent value, just the price someone is willing to pay for them (or is that theory restricted to labour and not applied to corporeal goods?)

  52. Posted May 8, 2012 at 8:29 pm | Permalink

    DEM@52 No, I meant borrowing the cow (remember, I was giving an example of credit in a barter economy).

    If you borrowed the cow and gave it back intact but otherwise paid nothing, that would be like borrowing money with no interest (as friends and family do lots).

    If you borrowed the cow but agreed to pay a chicken each week you held on to the cow, the weekly chicken would be the interest rate on cow borrowing.

    So, if you want to think of interest rates as the price of renting money, sure.

  53. Posted May 8, 2012 at 8:31 pm | Permalink

    kvd@51 But if most of what you brought up had nothing to do with monetary policy (and it didn’t) then it had nothing to do with monetary policy. So it is fine to discuss monetary policy in terms of only stuff that is actually relevant to monetary policy.

  54. kvd
    Posted May 9, 2012 at 4:55 am | Permalink

    Something is missing in this story; that a lot of capital was looking for safe havens.
    and
    Australian financial institutions were not much affected by the GFC [….] in part, because of superior prudential regulation.
    and
    Australian banking trade-off where the “four pillars” have some level of protection in return for strong prudential oversight.
    and
    The RBA is also an example of the Australian ability to “do” bureaucracy.
    and
    … if the US, the UK and the Eurozone had had central banks as competent and accountable as the RBA.

    All comments I agree with, and part of ‘the A-model’ which interests me. But if you now say they are not “actually relevant” to your own interests I will politely withdraw.

  55. Posted May 9, 2012 at 5:26 am | Permalink

    kvd@55 As i said, these are comparative, not absolute judgements. Are our institutions perfect? Of course not. Are there potential problems? Yes. But if the BoJ, Fed,ECB and BoE were as competent and accountable, and well-targeted as the RBA would things be much better? Yes.

  56. kvd
    Posted May 9, 2012 at 6:01 am | Permalink

    Yes – I believe so. And I’m sorry about the bold – it looks like shouting which was not my intent; should have used italics I guess.

  57. Posted May 9, 2012 at 2:04 pm | Permalink

    Who said anything about looser credit? I know folk talk about monetary policy in terms of interest rates, but there is more to monetary policy than interest rates.

    When I hear that from people like Scott Sumner, they’re usually suggesting the Fed needs to tell people to expect more inflation so that it will become a self-fulfilling prophecy, but I doubt you’re suggesting that the Fed won’t be able to create inflation expectations if it fears fiscal policy might cause inflation. So seriously, has any central bank ever successfully stimulated the economy without dropping rates?

    Interest rates are higher in Australia than the US.

    Could that be part of why the RBC has been more successful in managing the crisis? I see the RBC did lower rates during the recession, and in fact rates haven’t returned to pre-recession levels.

    Also, there is reason to believe that interest rates are in long-term decline, particularly in the US, since it has remained such a preferred safe haven for capital from the developing world (which is getting more prosperous, so producing more savings and thus more capital).

    Just because there’s a reason for it doesn’t mean it is inevitable. If congress pursued a long term strategy of more fiscal stimulus, the Fed would meet their inflation targets by raising rates. So whatever is driving rates down, if we want rates to vary around the rates we had in the 90s (as I think we should), fiscal expansion could make that happen, whereas the Fed could not make it happen.

    I would not hold the Fed solely responsible.

    I would not hold them at all responsible. We haven’t had inflation problems, so they shouldn’t have at any point tried to push them higher.

    Yes, the monetary authority moves last. So, the US gets as much stimulus as the Fed is happy with.

    Assuming the Fed can provide as much as it wants. In that case, yes, fiscal policy just determines what interest rate we have during the stimulus, and during the boom determines whether credit is efficiently allocated to subprime mortgages or inefficiently allocated to rebuilding public infrastructure.

  58. Posted May 9, 2012 at 2:23 pm | Permalink

    EL@58 I suspect we are mostly in furious agreement.

    So seriously, has any central bank ever successfully stimulated the economy without dropping rates?

    Real or nominal? Part of the point of creating inflation expectations at the zero bound is to push real interest rates lower.

    Yes, that the RBA has never wandered near the zero bound does make managing monetary policy easier. But part of the effect of the way the RBA manages monetary policy is that it was much less risk of running into the zero bound.

    whereas the Fed could not make it happen.

    Yes it could. If it told people it would do whatever it took to get NGDP growth to 5%, that would be stimulatory.

    Part of what makes the RBA different is that it manages income expectations as well as inflation expectations.

    is efficiently allocated to subprime mortgages or inefficiently allocated to rebuilding public infrastructure.

    Irony is always risky in writing ;)

  59. kvd
    Posted May 12, 2012 at 6:54 am | Permalink

    Interesting article Lorenzo, which would seem to reinforce your own view as to the competency of the RBA, but also that the board members can sometimes be influenced by self interest, or at least the interests of their constituencies.

    I know, I know – nothing to do with monetary policy ;)

  60. Nathanael
    Posted May 13, 2012 at 8:36 am | Permalink

    kvd, I think you’re seeing the Tammany Hall phenomenon — namely, people will tolerate a lot of self-dealing corruption *as long as the important functions of government get done*. The moment they fail to get stuff done — as when the Tweed Courthouse managed to have so much graft that the graft used up all the money and the courthouse wasn’t actually finished — THEN it became possible to break Tammany Hall.

One Trackback

  1. By Skepticlawyer » The year in review on December 30, 2012 at 1:01 am

    [...] Eagle’s first book is published, guest poster Jacques starts a diet riot, Lorenzo comments on the success of Australian economic policy while I conclude our Hunger Games series started two months [...]

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