business cycles

Boom and Bust — Different Ideas Why…

by Alex Schibuola on October 22, 2010

in Economy

This is a great post by Lee Doren. He’s spot on pointing out that “the [video producers/Larry White] don’t claim that 100 percent of the disruptions in the market are caused by the Federal Reserve.” After all, boom and bust cycles, or business cycles, existed even before central banks — not that governments didn’t tamper with money before central banks. I wanted to elaborate on this business cycle theme a little by providing a (very brief) outline of some other theories of business cycles.

Essentially, there are two largely different schools: Austrian and neoclassical. When Keynes published his General Theory Employment, Interest, and Money in 1936, this created modern neoclassical macroeconomics. F.A. Hayek had a competing book that was supposed to strengthen Austrian macroeconomics, the Pure Theory of Capital (1941). The book was a dismal mess and Austrian Business Cycle theory became latent (although Austrian macroeconomics appears to be making a comeback 60 years later). I won’t elaborate on the differences between those two schools here, because I want to take a look at the three neoclassical theories on business cycles. One of these shares characteristics similar to Austrian macroeconomics:

(1) New Keynesians assume that prices and wages are “sticky.” Sticky prices and wages indicate that it takes a long time (like 3 months or more, rather than minutes) for prices and wages to adjust to their correct levels. Keeping in mind that the price system exists to coordinate where resources flow to and from, if prices and wages don’t change quickly enough, then resources won’t flow to and from where they need to. This is why New Keynesians argue that government intervention is necessary — in order to push prices and wages up to where the resources could be flowing to and from where they’re needed.

(2) At the polar extreme of New Keynesianism, Real Business Cycle (RBC) theorists believe that business cycles are driven by “real shocks” (or “productivity shocks”). Unlike the New Keynesians, RBC assumes that prices and wages adjust really quickly (i.e., they’re not sticky but flexible) and that central banking policy doesn’t have any real effects on the economy (i.e., so no Austrian-style business cycles). Real shocks include new technological developments (e.g., the Internet), wars, natural disasters, etc. RBC argues that the economy is continuously buffeted by these real shocks. A cluster of positive shocks (e.g., new technology) leads to booms and a cluster of negative shocks (e.g., high oil prices, natural disasters) lead to busts.

(3) New Keynesians and RBC are the two extreme sides of the neoclassical schools. In between the two is the New Classical theory. In the world we live in there are two types of price changes we observe: (1) real changes, where society actually values a particular good more or less and (2) inflationary price changes, where all prices rise because there’s more money being printed by the central bank and it’s not because society changes how it values some goods over others. If a central bank starts printing more money and causes all prices to inflate, businesses might mistake this with a real change in the demand for their goods. So they’ll say, “Oh, the price of my product is rising, I should produce more, because people are demanding more. If all businesses think the same way, they all produce more, and we get a boom. Later on it’s discovered that it was all inflation from the central bank, they’ll cut production and labor, and we end up in a recession.

Most macroeconomists don’t strictly subscribe to one theory or the other. The New Keynesians tend to think markets don’t work well, whereas RBC and New Classical economists have faith in markets. The New Classical School in particular does share many characteristics with the Austrian Business Cycle theory, particularly regarding central banks as the cause of business cycles.

Financial Fiasco

by Ryan Young on December 12, 2009 · 2 comments

in Deregulate to Stimulate, Economy, Regulation, Stimulus to Nowhere

I recently finished reading Swedish economist Johan Norberg‘s book about the financial crisis, aptly titled Financial Fiasco. It’s both short and informative. Six chapters and 155 pages, all of them worth reading.

The first two chapters are about the two big regulatory causes of the recession. One, monetary policy that was too easy for too long. The price system works. When the Fed messes with that price system, prices send out the wrong signals. People behave accordingly. Two, a decades-long drive to raise homeownership rates caused a lot of people to take out loans they couldn’t afford. It was only a matter of time before the consequences would come to bear.

Chapters 3 and 4 are about how the private sector reacted to the incentives regulators gave them. Let’s just say they acted badly. If people can game the system, they often will. Norberg’s criticism of overly-complicated securitized mortgage packages is both shocking and infuriating.

Chapter 5 is about how the government and private sector reacted to the crisis once the housing bubble popped. The $700 billion bailout program to reward bad behavior comes under fire.

Norberg is in top form in Chapter 6. Having looked at the causes and consequences of the crisis, now he offers a way out. One lesson is that politicians will always behave badly. “Politicians who distribute pork they cannot afford are reelected; butcher shops that sell pork they cannot afford go bankrupt. (p. 150)” Politicians are just like you and me. They go wherever their incentives lead them. We need to approach them accordingly.

The way to a full recovery is not bailouts. It is letting bad companies fail. And just as important, letting good ones prosper. “Government support for companies is thus not a way to save jobs, as politicians try to make us believe. It is a way to move jobs from good companies to bad companies.” (p. 151) In the long run, bailouts keep the economy down by keeping jobs and resources away from where they would do the most good.

Financial Fiasco has echoes of Tocqueville; a foreigner is trying to figure out how America works. Norberg, like Alexis de Tocqueville, is uncommonly perceptive. His experience living under an economy more thoroughly mixed than America’s allows him to see things that have escaped American commentators. This is extremely valuable. The fact that his book is concise, well written, and accessible to those of us who don’t have economics Ph.Ds makes it even moreso.

Did Deregulation Cause the Great Recession?

by Ryan Young on December 8, 2009 · 2 comments

in Bailout Watch, Deregulate to Stimulate, Economy, Employment, Regulation, Stimulus to Nowhere

Over at RealClearMarkets, I explain why the answer is a resounding no:

Rep. Phil Hare argues that “reckless deregulation” is one of the causes of the current economic crisis. That isn’t actually true. This year’s edition of the Competitive Enterprise Institute’s Ten Thousand Commandments report found that 3,830 new regulations came into effect in 2008 alone.

Over 30,000 total new rules passed during the Bush years. Hardly any were repealed. Businesses currently dole out the equivalent of Canada’s entire 2006 GDP – about $1.2 trillion – just to comply with federal regulations.

Where is the deregulation?

263,989 people make their living working for federal regulatory agencies, according to research from the Mercatus Center. That’s an all-time high.

12,190 of them regulate financial markets from Washington. More are based in New York and other financial centers. None of these figures include state and local rules and regulators. Those cost extra.