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Business Cycles - Jonathan Newman

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Business Cycles - Jonathan Newman

  1. 1. BusinessCycles Jonathan Newman Mises Boot Camp 2015
  2. 2. Whatisa businesscycle? • What it is not: Business fluctuations • Changes happen all the time and are necessary for a functioning market economy (production, consumption, preferences, resources) • Entrepreneurs have the task of dealing with and anticipating these changes by putting resources on the line in such a way to satisfy consumer demands. • Good choices mean growth, bad choices mean decline • But, bad entrepreneurs suffer losses and good entrepreneurs gain profits
  3. 3. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  4. 4. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  5. 5. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  6. 6. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  7. 7. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  8. 8. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  9. 9. Whatisa businesscycle? • General boom and general bust • We see patterns in economic data like this
  10. 10. Whatisa businesscycle? • General boom and general bust • Consumer prices vs. factor prices • Rothbard, America’s Great Depression p. 9: “capital-goods industries fluctuate more widely than do the consumer-goods industries”
  11. 11. Whatisa businesscycle? • General boom and general bust • Consumer prices vs. factor prices • Rothbard, America’s Great Depression p. 9: “capital-goods industries fluctuate more widely than do the consumer-goods industries”
  12. 12. Whatisa businesscycle? • General boom and general bust • Theory must account for these phenomena: • The “shape” or stages of the cycle: boom then depression • The cluster of entrepreneurial errors • The more dramatic fluctuations in capital-goods industries compared to consumer-goods industries • Suspects: • Money • Credit
  13. 13. Whatisa businesscycle? • General boom and general bust • Theory must account for these phenomena: • The “shape” or stages of the cycle: boom then depression • The cluster of entrepreneurial errors • The more dramatic fluctuations in capital-goods industries compared to consumer-goods industries • Suspects: • Money • Credit
  14. 14. Whatisa businesscycle? • General boom and general bust • Theory must account for these phenomena: • The “shape” or stages of the cycle: boom then depression • The cluster of entrepreneurial errors • The more dramatic fluctuations in capital-goods industries compared to consumer-goods industries • Suspects: • Money • Credit
  15. 15. Whatisa businesscycle? • General boom and general bust • Theory must account for these phenomena: • The “shape” or stages of the cycle: boom then depression • The cluster of entrepreneurial errors • The more dramatic fluctuations in capital-goods industries compared to consumer-goods industries • Suspects: • Money • Credit
  16. 16. Whatisa businesscycle? • General boom and general bust • Theory must account for these phenomena: • The “shape” or stages of the cycle: boom then depression • The cluster of entrepreneurial errors • The more dramatic fluctuations in capital-goods industries compared to consumer-goods industries • Suspects: • Money • Credit • Nick Cage?
  17. 17. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  18. 18. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  19. 19. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  20. 20. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  21. 21. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  22. 22. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  23. 23. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  24. 24. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  25. 25. Malinvestment • Investment in unprofitable lines of production induced by artificially low interest rates • Profits anticipated ex ante • Profits/losses realized ex post • Need to explain how interest rates influence production • Good candidate because… • Explains boom (increased investment) • Explains bust (liquidation) • Explains cluster of errors • Related to money and credit • Related to capital markets
  26. 26. StructureofProduction • Factors of production are employed together to make consumer goods • Requires laborers using land and capital • Complex, heterogeneous, interwoven, “latticework” • Takes time (stages) • What does it look like?
  27. 27. StructureofProduction • Factors of production are employed together to make consumer goods • Requires laborers using land and capital • Complex, heterogeneous, interwoven, “latticework” • Takes time (stages) • What does it look like? Böhm-Bawerk
  28. 28. StructureofProduction • Factors of production are employed together to make consumer goods • Requires laborers using land and capital • Complex, heterogeneous, interwoven, “latticework” • Takes time (stages) • What does it look like? Böhm-Bawerk Hayek
  29. 29. StructureofProduction • Factors of production are employed together to make consumer goods • Requires laborers using land and capital • Complex, heterogeneous, interwoven, “latticework” • Takes time (stages) • What does it look like? Böhm-Bawerk Hayek
  30. 30. StructureofProduction • Factors of production are employed together to make consumer goods • Requires laborers using land and capital • Complex, heterogeneous, interwoven, “latticework” • Takes time (stages) • What does it look like? Böhm-Bawerk Hayek Rothbard
  31. 31. StructureofProduction • Factors of production are employed together to make consumer goods • Requires laborers using land and capital • Complex, heterogeneous, interwoven, “latticework” • Takes time (stages) • What does it look like? Böhm-Bawerk Hayek Rothbard Garrison
  32. 32. Timepreference • We all prefer a given satisfaction sooner rather than later • Variety of rates of time preference, and so there is an opportunity to trade David $1200 F $1000 P $1100 F : $1000 F Jeff $1100 F $1000 P $1050 F : $1000 F interest rate loans S D
  33. 33. Productionandtheinterestrate • Since production takes time, the costs of production (purchasing, renting, and hiring factors) precede revenues from the sale of output • Therefore anticipated future profits are compared to returns that could be earned by lending at interest • Suppose Nick could earn 5% interest by lending, but has an idea for a product he thinks he could produce and sell for a 7% return. • Nick increases his demand for factors, engages in production, and puts his product on the market. • No matter the outcome (profit or loss), Nick has pushed up the price of factors because the interest rate was lower than his anticipated rate of profit. • What about the opposite?
  34. 34. Saving andgrowth • We save more at a lower rate of time preference because we discount the future less. • When we save, a few things happen: • First, and most obvious, we decrease consumption. Fewer resources are consumed in the present. • The supply of loanable funds increases. More people are willing to part with more of their money in the present in exchange for the promise of future returns. • The interest rate falls, and production is restructured for longer lines of production. • Factor price relationships change as earlier stages see a greater increase in demand than later stages. Late stage factor demand will decrease as consumers consume less to save more.
  35. 35. Saving andgrowth • We save more at a lower rate of time preference because we discount the future less. • When we save, a few things happen: • First, and most obvious, we decrease consumption. Fewer resources are consumed in the present. • The supply of loanable funds increases. More people are willing to part with more of their money in the present in exchange for the promise of future returns. • The interest rate falls, and production is restructured for longer lines of production. • Factor price relationships change as earlier stages see a greater increase in demand than later stages. Late stage factor demand will decrease as consumers consume less to save more.
  36. 36. Saving andgrowth • We save more at a lower rate of time preference because we discount the future less. • When we save, a few things happen: • First, and most obvious, we decrease consumption. Fewer resources are consumed in the present. • The supply of loanable funds increases. More people are willing to part with more of their money in the present in exchange for the promise of future returns. • The interest rate falls, and production is restructured for longer lines of production. • Factor price relationships change as earlier stages see a greater increase in demand than later stages. Late stage factor demand will decrease as consumers consume less to save more.
  37. 37. Saving andgrowth • We save more at a lower rate of time preference because we discount the future less. • When we save, a few things happen: • First, and most obvious, we decrease consumption. Fewer resources are consumed in the present. • The supply of loanable funds increases. More people are willing to part with more of their money in the present in exchange for the promise of future returns. • The interest rate falls, and production is restructured for longer lines of production. • Factor price relationships change as earlier stages see a greater increase in demand than later stages. Late stage factor demand will decrease as consumers consume less to save more.
  38. 38. Saving andgrowth • We save more at a lower rate of time preference because we discount the future less. • When we save, a few things happen: • First, and most obvious, we decrease consumption. Fewer resources are consumed in the present. • The supply of loanable funds increases. More people are willing to part with more of their money in the present in exchange for the promise of future returns. • The interest rate falls, and production is restructured for longer lines of production. • Factor price relationships change as earlier stages see a greater increase in demand than later stages. Late stage factor demand will decrease as consumers consume less to save more.
  39. 39. Saving andgrowth
  40. 40. Saving andgrowth • Result: greater production in the long run • Saving today frees up resources for productive uses which yields more output tomorrow
  41. 41. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  42. 42. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  43. 43. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  44. 44. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  45. 45. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  46. 46. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  47. 47. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  48. 48. Artificialcreditexpansion • Central bank can expand credit without an economy-wide increase in savings • Newly created money enters the economy through credit markets and so represent an increased supply of loanable funds • Interest rate falls, but not because of a decrease in time preference • At the lower interest rate, saving decreases • Consumption and borrowing increase • Firms take the new funds and try to invest in new, longer lines of production • Factor prices are bid up across the board.Wages increase, employment increases, consumption increases, investment spending increases. • In short, we have a general boom.
  49. 49. Artificialcreditexpansioncauses overconsumptionandmalinvestment • Consumers did not show they preferred future output to present output, in fact, they decreased saving at the lower interest rate. • The credit expansion does not represent an increase in real resources available for consumption or investment. • Factors of production become increasingly scarce • Prices are bid up higher than entrepreneurs expected • Costs increase: expected profits turn into losses • Entrepreneurs were led to believe consumers had saved, real resources were available for production, and that longer production would be profitable.
  50. 50. Artificialcreditexpansioncauses overconsumptionandmalinvestment • Consumers did not show they preferred future output to present output, in fact, they decreased saving at the lower interest rate. • The credit expansion does not represent an increase in real resources available for consumption or investment. • Factors of production become increasingly scarce • Prices are bid up higher than entrepreneurs expected • Costs increase: expected profits turn into losses • Entrepreneurs were led to believe consumers had saved, real resources were available for production, and that longer production would be profitable.
  51. 51. Artificialcreditexpansioncauses overconsumptionandmalinvestment • Consumers did not show they preferred future output to present output, in fact, they decreased saving at the lower interest rate. • The credit expansion does not represent an increase in real resources available for consumption or investment. • Factors of production become increasingly scarce • Prices are bid up higher than entrepreneurs expected • Costs increase: expected profits turn into losses • Entrepreneurs were led to believe consumers had saved, real resources were available for production, and that longer production would be profitable.
  52. 52. Artificialcreditexpansioncauses overconsumptionandmalinvestment • Consumers did not show they preferred future output to present output, in fact, they decreased saving at the lower interest rate. • The credit expansion does not represent an increase in real resources available for consumption or investment. • Factors of production become increasingly scarce • Prices are bid up higher than entrepreneurs expected • Costs increase: expected profits turn into losses • Entrepreneurs were led to believe consumers had saved, real resources were available for production, and that longer production would be profitable.
  53. 53. Artificialcreditexpansioncauses overconsumptionandmalinvestment • Consumers did not show they preferred future output to present output, in fact, they decreased saving at the lower interest rate. • The credit expansion does not represent an increase in real resources available for consumption or investment. • Factors of production become increasingly scarce • Prices are bid up higher than entrepreneurs expected • Costs increase: expected profits turn into losses • Entrepreneurs were led to believe consumers had saved, real resources were available for production, and that longer production would be profitable.
  54. 54. Artificialcreditexpansioncauses overconsumptionandmalinvestment • Consumers did not show they preferred future output to present output, in fact, they decreased saving at the lower interest rate. • The credit expansion does not represent an increase in real resources available for consumption or investment. • Factors of production become increasingly scarce • Prices are bid up higher than entrepreneurs expected • Costs increase: expected profits turn into losses • Entrepreneurs were led to believe consumers had saved, real resources were available for production, and that longer production would be profitable.
  55. 55. Artificialcreditexpansion
  56. 56. Depression • Firms attempt to liquidate malinvested capital • Wages decrease and workers are laid off • Credit markets dry up • Prices readjust to reflect consumer demands • Inputs and outputs • Depression is a recovery phase as people try to find profitable uses for capital and labor
  57. 57. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Cause Expansionary monetary policy Cause #2 Malinvestment Cure Markets Cure, restated Let consumer demand dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions
  58. 58. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Bust-boom Cause Expansionary monetary policy Cause #2 Malinvestment Cure Markets Cure, restated Let consumer demand dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions
  59. 59. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Bust-boom Cause Expansionary monetary policy Instability of investment spending Cause #2 Malinvestment Cure Markets Cure, restated Let consumer demand dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions
  60. 60. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Bust-boom Cause Expansionary monetary policy Instability of investment spending Cause #2 Malinvestment Fall in aggregate demand Cure Markets Cure, restated Let consumer demand dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions
  61. 61. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Bust-boom Cause Expansionary monetary policy Instability of investment spending Cause #2 Malinvestment Fall in aggregate demand Cure Markets Expansionary monetary policy and fiscal policy Cure, restated Let consumer demand dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions
  62. 62. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Bust-boom Cause Expansionary monetary policy Instability of investment spending Cause #2 Malinvestment Fall in aggregate demand Cure Markets Expansionary monetary policy and fiscal policy Cure, restated Let consumer demand dictate prices and resource allocation Let the government dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions
  63. 63. Contrasting business cycle theories Austrian Keynesian Shape Boom-bust Bust-boom Cause Expansionary monetary policy Instability of investment spending Cause #2 Malinvestment Fall in aggregate demand Cure Markets Expansionary monetary policy and fiscal policy Cure, restated Let consumer demand dictate prices and resource allocation Let the government dictate prices and resource allocation Prevention Don’t give money production authority to non-market institutions Give the government control of money production and a blank check for spending
  64. 64. Conclusion • We can successfully explain business cycles using malinvestment concept • Investment in unprofitable lines of production induced by artificially low interest rates • Theory must account for these phenomena: • The “shape” or stages of the cycle: boom then depression • The cluster of entrepreneurial errors • The more dramatic fluctuations in capital-goods industries compared to consumer-goods industries • Original suspects: • Money • Credit

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