30 Aug 2008

Does Tyler Cowen Really Not Endorse ABCT, Or Is He Just Yanking My Thread?

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In a previous post, I explained that Tyler Cowen unwittingly proved the predictive power of Austrian business cycle theory (ABCT) several years ago, in a post titled (a la OJ Simpson) “If I believed in Austrian business cycle theory…”

But oops Tyler did it again in his recent New York Times article. Seriously, there are some very ABCT-ish passages in this article, such as:

Behind every financial crisis there is usually a crisis in the real economy, based in some underlying structural deficiency…

The third problem is that lower consumer spending will require the American economy to make some shifts. That may mean fewer Starbucks and fewer new homes but more tractor production for export to foreign markets. In the long run, shifting some consumption to investment is probably beneficial to the economy; in the short run it means job losses and costly readjustments.

In addition, there are still excess homes on the market, and housing prices need to fall further. Of course, such price declines can make banks less solvent and thus worsen the credit crisis. And politicians would like to moderate this fall in prices, again prolonging the adjustment process…

What should policy makers do? One path that is likely to prove counterproductive is further fiscal stimulus in the form of tax rebates. Such stimulus can raise consumer spending and bolster the economy in the short run, but it works — if it works at all — only by pushing consumers to spend rather than to save. It merely postpones needed adjustments by providing a grab bag of goodies at exactly the wrong time.

Now I grant you, Tyler’s* article isn’t a canonical exposition of the ABCT; for that, I naturally direct you to something I wrote.

But what’s really touching/frustrating, is that Tyler is begging for a business cycle theory to organize all of his (good) intuitions. In the MR post where he promotes his NYT article, Tyler explains:

I’ve become increasingly interested in how an economy can be “tangled up,” a notion I first learned from Axel Leijonhufvud. The literature on self-organizing critical systems considers this idea, but I don’t think it has been expressed in simple, intuitive form and in a manner that can be integrated with other macroeconomic ideas.

Seriously, folks, ABCT is just what the doctor (not an MD, mind you) ordered. The Austrian theory explains how artificially low interest rates (caused by Fed injections of phony credit) lead to unsustainable investments. The economy’s capital structure is a complex web of interrelated processes, and most schools of thought don’t model it at a rich enough level to capture this. So that’s why only the Austrians have a chance of explaining what happened in the recent housing boom-and-bust. There’s more to the story than simple “greed,” because speculators and real estate agents were greedy in the 1990s too.

If you really want to see the Austrian story of how the Fed sets in motion an unsustainable expansion–how things get “tangled up” if you like–I encourage you to watch Roger Garrison’s phenomenal PowerPoint shows. Really first rate stuff.

* After you criticize someone in 25 separate blog posts, you earn the right to call him by his first name, correct?

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