17 Feb 2011

Charles Plosser, Our Man on the Fed?

Economics, Federal Reserve, Shameless Self-Promotion 15 Comments

I explain at Mises.org. However, we Austrians must always engage in product differentiation and so:

[B]ecause the Austrians have a rich model of capital, they can explain why a painful bust, or recession, is necessary. In other words, after the central bank backs off and lets interest rates rise to their correct level, the entrepreneurs and workers can’t simply slap their foreheads and say, “Whoops, let’s try that again.” The economy can’t simply revert to its position on the eve of the boom, because irrevocable investment decisions have been made.

This point actually shows the deficiency in the focus on worker retraining, exhibited by Plosser in the quotation above, or by Chicago School economist John Cochrane, who argued in late 2008, “We should have a recession. People who spend their lives pounding nails in Nevada need something else to do.”

By focusing primarily on skill/occupation mismatch, Plosser and Cochrane overlook the important role of capital consumption during the boom period, which Mises emphasized. If a recession were merely about retraining workers, then Krugman’s critique of the Austrian theory would make more sense: after all, it presumably took some time to train the new construction workers (and investment bankers) when they went into their occupations during the housing boom, so why are we stuck with an awful recession when they need to leave those industries?

But as my simple sushi story demonstrated, we can easily understand a large surge in unemployment when we realize that the underlying capital structure — the tools, equipment, and goods-in-process — of the whole economy went along for the ride too.

For a snappy quotation to supplement Cochrane’s, I’d say this: After the housing bubble burst, the problem wasn’t just that some construction workers should have been busboys; the problem was also that some backhoes should have been ovens.

15 Responses to “Charles Plosser, Our Man on the Fed?”

  1. RG says:

    Sorry to be nitpicky, Bob, but wouldn’t short order grills be a better than ovens? I think the bus boy/oven relationship is easily understood by most of us that are familiar with ABCT, but ovens are used to produce bricks, lumber, etc.

  2. AP Lerner says:

    I’m curious. You often write about capital structure. This is a good thing, and often overlooked by many economist and arm chair economist these days. However, when you write about the Fed, banks, quantitative easing, excess reserves etc, you seem to forget about capital structure.

    For example, in this post where you claim banks are “quite obviously “creating money out of thin air.””


    You do not even mention capital except in passing. And of course, anyone that understands banking, knows capital, not reserves, are required for banks to make loans.

    For example, it is your position (I believe, this is your position, stated simplistically) that because of the Fed buying treasuries in mass, there has been a build up of reserves in the banking system. These excess reserves will allow banks to become ‘loaned up’

    However, in order for banks to grow their balance sheets, or become more ‘loaned up’, capital must also be raised, right?. Banks cannot grow their balance sheets without capital, right? But in much of your commentary, you state banks will become more ‘loaned up’ just because there is an excess amount of reserves.

    Are you implying the reserves are in fact additional capital? Does an increase in reserves allow a bank to grow its balance sheet in lieu of raising additional capital? Or is it your claim there is an abundance of excess capital in the banking system?

    Maybe there is an essay you have written that I have not come across that addresses this point, and if so, is someone in the comments would share, I would be very interested in reading.

    • Jonathan M. F. Catalán says:

      Are you talking about capital in the financial sense? The capital structure deals with tangible capital goods, not capital in the financial sense.

    • Bob Roddis says:

      APLerner is hunting for Bob Murphy to make some error in explaining technical banking operations and will then use that error as evidence of the alleged silliness of Austrian “ideology”. He claims:

      Ron Paul does not understand the monetary [system] of the US. Someone should explain to him that we left the gold standard decades ago, government debt issuance is a monetary operation, not a fiscal one, and public deficits are necessary for private savings when the external balance is negative.

  3. AP Lerner says:

    “The capital structure deals with tangible capital goods, not capital in the financial sense”

    Banks need capital and have capital structures, right? It may not consist of physical capital like machines and equipment, like a restaurant requires, but don’t banks require capital to generate revenues and profits, much like the ovens that are required to employ the busboy in the example above. Isn’t common stock a form of capital?

    A banks capital required to generate revenues and profits is ignored in this essay:
    Maybe Mr. Murphy was not given enough space to include a discussion on capital in that essay. Not sure. But to claim banks can create money out of thin air without mentioning required capital seems a bit incomplete.

    So I guess my question is, when it is stated that excess reserves will ultimately lead to banks becoming more and more loaned up, when does capital, and capital structure come into the picture? All of the discussion about reserves finding there way into the private sector via QE seems to ignore the required capital that is necessary for banks to become more ‘loaned up’?

    Can banks really grow their balance sheets w/ out additional capital? Or is the conclusion the excess reserves increase a banks capacity to lend, regardless of its capital position?

    • bobmurphy says:

      I’m not sure what you’re looking for, but in this lecture I went through the balance sheet of a fractional reserve bank. I talked about capital, leverage, etc.

      I don’t know if I’ve written about it on Mises.org, but I certainly have said in lectures and on the radio that the banks are currently capital-constrained, and that’s partly why they’re not lending more.

      • Bob Roddis says:

        APLerner was looking for an admission from Bob Murphy that he somehow got a PhD from NYU in economics without understanding the capital requirements of banks which would have meant the demise of the entire Austrian School.

        • bobmurphy says:

          Heh I appreciate the vote of confidence, but I certainly was able to get a PhD from NYU in economics without learning anything about capital requirements of banks. That stuff I learned on my own, most of it after I had a PhD from NYU.

          I don’t think we ever talked about a commercial bank in the entire 5 years I was at NYU. I’m not even kidding.

          • Bob Roddis says:

            Anyway, thanks for saving the Austrian School from certain demise at the hands of APLerner.

  4. RG says:

    Capital = savings

  5. Abba P Lerner - Economic Bafoon says:


    Banks cannot grow their balance sheets without capital. However, you have ask yourself where did the capital come from when they were recapitalized by the Fed (aka bailouts)? Capital in the form of purchasing power was diverted from anyone holding dollars and given to the banks. It was a giant wealth transfer from holders of dollars to the banks.

  6. Captain_Freedom says:

    For a snappy quotation to supplement Cochrane’s, I’d say this: After the housing bubble burst, the problem wasn’t just that some construction workers should have been busboys; the problem was also that some backhoes should have been ovens.

    Bingo. The economy does not facilitate the production of “workers” for our consumption, it facilitates the production of goods and services.

    • Tom E. Snyder says:

      I agree. A great quote.

  7. Bob Roddis says:

    1. Since we were dealing with AP Lerner and the Chartalists, I want to point out that not only are there no people in Chartalist-land, but there are no backhoes or ovens either.

    2. I listened to the Tom Woods interview with Dennis Miller. Tom said that the promises made pursuant to the government’s massive debt can only be satisfied with depreciated worthless money. That claim appears to be completely denied by the Chartalists who seem to insist that a few monetary and fiscal manipulations can cure our debt problem, which therefore isn’t really a problem at all. But they won’t answer the question: “Where’s all the stuff going to come from to satisfy this debt?” I’m turning purple holding my breath waiting for an answer.

  8. Spectre says:

    @ AP Lerner:

    I’m not sure how you define “capital,” but I’ll admit people seem to throw the term around fairly loosely, at least in the mainstream.

    “Capital” may go by other terms such as REAL value, REAL savings, REAL equity, Net REAL assets etc. If we want to be sticklers on definitions, then “capital” is best defined as: the REAL resources (means) AVAILABLE for productive or consumptive purposes (ends).

    Now let’s start with first principles:
    Human wants and needs are infinite, thus, demand is unlimited. At this moment in time physical matter is finite (law of conservation), thus, supply is limited. There are two kinds of demand: 1) The demand for inputs to produce outputs, i.e. production and, 2) The demand for outputs to “use up,” i.e. consumption. Production is a value-adding activity. Consumption is a value-substracting activity.

    Applying Business School “Value-Chain Concept” as Austrian Capital Structure Theory:
    The economy at any point in time necessarily has a “value-driven structure.” That is, the economy may have its “supply/value-chain” (i.e. capital structure) “coordinated” in such a way, that on net balance, production > consumption (value creation), production = consumption (neutral), or consumption > production (value destruction).

    Consider the last case, where consumption > production. If the economy’s trajectory persists in the “consumption > production value-driven structure” to the point that on net balance, the economy is subtracting value, a corrective recession/depression sets in. The length of the recession/depression depends entirely on how quickly the economy can “re-coordinate” its “supply/value-chain” (i.e. capital structure) to one where on net balance production > consumption, that is, back to a “value-adding structure.”

    Applying the Above Concepts to Modern Times:
    Let’s restate our definition of “capital”: The REAL resources (means) AVAILABLE for productive or consumptive purposes (ends).

    AP, This might be disillusioning for you, as my Keynesianism Detector senses you maybe under the “phantom capital” spell. So pay attention.
    Notice how I emphasized the words, “real” and “available?” That isn’t by mistake. The economy is constrained to “capital” that is “real” and “available.” Creating new claims on resources (money) does not create “capital” nor does it make existing “capital” available – if anything, it does the EXACT OPPOSITE! Those people who hold the existing “capital” don’t want to make their “capital” available at such low interest rates and risk losing purchasing power with potential negative returns due to increased price-inflation expectations (which expansion of the money supply does – even Mishkin’s Textbook says so).

    Make no mistakes about it AP. Capital is very real, and very available – if the terms are favorable for investors/creditors (i.e. capital holders), which of course they aren’t in todays envronment. Here are my two axioms for economics: 1) Existing capital goes to where it is treated best. 2) Capital is created when we produce more than we consume.

    It summary, it amazes me that people can understand the value/supply-chain in terms of economics for a business, but fail to understand that the same concept applies to the macro-economy. It’s truly astounding, it really is.