What's the monetarist criticism of the austrian theory of the business cycle?

Discussion in 'Economics' started by Daal, Nov 27, 2006.

  1. Daal


    I saw an interview where friedman even questions 'if there is such thing as a business cycle' and another one where states about the theory 'a theory which I believe is wrong but it was an important step on finding the right ideas'
    Does anyone have the reasons for this?That theory makes a lot of sense to me
  2. Their data is comparing economies where money supply & credit is pretty much constant vs economies where money supply & credit goes through up & down cycles (like US).

    Not suprisingly, it is noticed that the "business cycle" has a very strong correllation with money supply and credit. Interestingly enough, Soros has a couple similiar conclusions in his "Alchemy of Finance" book. He says that leverage & credit is why there are troughs & peaks in the "business cycle", but his theory of reflexivity states that the driving force is the stock expectations.

    An injection of liquidity spurs business growth as this money flows through the system. The companies adjust to this growth with projected estimates which is used to invest in the business and used to get more leverage. But once the liquidity is tightened and the leverage is harder to get, a shock occurs. All of the sudden, the companies are operating at way below capacity and the operations have to be tuned down. As the business goes down, the company is not really able to maintain their current debt service, yet at the same time is unable to refinance due to lack of liquidity in the system. If the company is public, then they have a whole another set of responsibilities & problems to deal with.
  3. The next financial crisis will have the distinction of being the first to resonate in financial markets around the world. I wonder how long we'll all get along once it hits. Can't wait to see who is on the other side of some these interest rate swaps and CDS
  4. nevadan


    Most who object to the Austrian School believe in Keynesian interventionism, where the government and central bank attempt to influence the economy by stimulating with cash infusions to reach some desired outcome. Austrians think that a free market that operates without interference will allocate to the most efficient producers the strongest position amongst competing entities, thereby utilizing scarce resouces most efficiently and producing what is most desired by the consumer. They are also advocates of a hard money system (the gold standard) which eliminates the government's ability to inflate away the purchasing power of a fiat currency, which acts as a tax on savings. Those who object the most to Austrian's stand to gain due to their postion at the head of the line of infusion recipients, in other words the government and banks who get the benefits of new money first.
  5. What about new gold hitting the market, it would also acts as a tax on savings? Maybe not a big tax, since the total amount of gold in the world could increase at a slower pace than real GDP. But then we would have natural deflation. Is that a problem? If not why not let the fed target a -2% inflation rate, then we could have inflation targeting without the inflation tax?
  6. nevadan


    Excellent question. It is true that an increase in the volume of gold money is in fact an inflation but the key distinction here is that as the volume of gold increases it tends to drive prices down, thereby increasing its purchasing power. Increasing the supply of paper money has exactly the opposite effect. As more fiat money becomes available producers are able to charge higher prices for the same goods which has the effect of reducing the purchasing power of the dollar. So money held in the form of gold actually increases in value while money saved in paper form is taxed away by inflation. A good example in the following link as to the enduring value in gold.

    Another argument in favor of gold is that it is a tangible asset that has other real uses for dentistry, jewelry, electronics, etc. and the new production of gold that is not consumed as a commodity will eventually find its way into a vault and is held as a store of value against which demand for payments can be made.

    The problem in a negative inflation (deflation) scenario with fiat currency is that the debts owed on current obligations remain the same in numerical terms while the price of assets fall, resulting in the borrower eventually owing more than the asset will bring at sale. The banker is forced to call for more collateral on the loan or force a sale to cover his position. Hence the phobia about deflation and the "desirability" of a low inflation rate.
  7. Yes newly mined gold is inflationary, but it requires a significant amount of work to extract the new gold. It can't be printed.

    Also, the productivity of society increases at a much faster rate than new gold is introduced so the overall effect is deflationary.

    As mentioned above, the only criticisms of the austrian theory come from those who want to control and intervene in the system. ie. Parasites.
  8. Thanks enlightening answers. I like the idea that on a full gold standard contributing people, capital owners, entrepreneurs and workers reap the rewards from the new money (gold) hitting the market.

    Traders can stabilize the economy no need for government or central bank interventions. I think it’s safer to give this crucial task to traders; they know supply and demand and have voting power according to their abilities. I think its traders who are doing the heavy lifting in the current regime, the fed probably look harder at the yield curve and the stock market performance than on hard numbers when they decide what to do.
  9. Sorry, wrong. An exogenous increase in the amount of gold, ceteris paribus, will drive down the price of gold in dollar terms thus reducing its purchasing power. Thus an ounce of gold in the long term will purchase fewer goods than before the gold level increase, which is inflation. It might simplify things if you get rid of the dollar measure and just look at the amount of goods that an ounce of gold buys under different scenarios. Prices are after all just exchange rates between different sets of goods. The dollar is just their unit of measure.
  10. nevadan


    Strictly speaking, yes. It is an oversimplification to say that the purchasing power of gold will not go down with an increase in supply. Inflation of the money supply is inflation of the money supply whether it is paper or metal. But as the producers of new money inflate the supply, they are also providing paying jobs, consuming products as the new money is being produced, and all the other benefits to society that come from creation of new wealth. The overall effect is to raise the standard of living for all as a wider variety of goods become available to a greater percentage of the population. This increase in prosperity has a net effect of lower prices as people become more affluent, all things being equal. (thanks, learned a new Latin phrase today ;-) )
    For an illustration of this the following link is a good read.
    #10     Dec 3, 2006