Toward a neo-Austrian theory of fiscal business cycles

by on March 12, 2017 at 12:46 am in Economics, Uncategorized | Permalink

In standard Austrian business cycle theory, artificially low rates of interest, as driven by monetary policy, induce investors to engage in too many long-term activities and overextend the structure of production.  A comeuppance later ensues, due to the malinvestments.

I suggest a very different fiscal version of this story.  Imagine a government that is perpetually in debt, and with voters who do not like new taxes, if you can stretch your mind that far.  There are also some constraints of borrowing.  The fiscal policy of this government thus is relatively active when interest rates are low, but contractionary when interest rates are high.  When interest payments eat up a smaller share of the federal budget, more goodies are given out.

In other words, with low interest rates, the government does indeed expand its activity, but in a manner oriented toward the present, through the medium of transfer spending.  Unlike private entrepreneurs the government is not a profit maximizer and instead it will pursue more votes when it can.

When interest rates eventually rise, money is taken away from transfer recipients and sent back to high-saving bondholders.  That is a kind of aggregate demand shock, or in Austrian terminology you could say that the structure of production had been geared too much toward the short term and now that is unsustainable and some adjustment costs will ensue.

The active agent here is government, and lower interest rates bring too much consumption, not too much investment.  An eventual reversal again creates some economic disruptions.  I think of that as Hayek’s theory in reverse.  When you mix that with the standard Hayekian account, I wonder how/whether those two kinds of disruptions interact.

1 derek March 12, 2017 at 12:57 am

We will find out won’t we.

It would depend on what increases the interest rates. There would be two scenarios, one where the overextended government has to pay higher rates to attract capital because of risk, or the cost of money increases due to demand for investment in other spheres. In the second scenario the low interest rates become entrenched as the increase in the cost of borrowing increases the extraction of resources from the economy, causing the initial demand increase to cool. So interest rates drop. Highly indebted governments with a large enough economy to supply it’s continuous borrowing needs cannot escape from low interest rates.

Except by the first scenario when the debt and costs get so out of control that government cannot borrow and interest rates rise as a result of a debt crisis.

Has there ever been a time when interest rates are so low?

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2 The Anti-Gnostic March 12, 2017 at 12:24 pm

Has there ever been a time when interest rates are so low?

I enjoyed Tyler’s essays on his hypothetical dog, Paco. (Just load it in the search box.) Investors and central banks bidding public and private bonds into zero-to-negative-interest territory implies zombie-army levels of risk out there, but where are the zombie armies? And on the other side of the equation, does anybody realistically think that debt measured in the trillions is going to be paid other than by the printing press? But the demand for debt instruments remains insatiable.

If the Austrians are right, we are headed for the Mother Of All Busts, but we just seem to keep cranking along. Japan, for example, just seems to keep cranking along.

Have we abolished Scarcity?

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3 TuringTest March 12, 2017 at 1:27 am

I guess the two theories cancel each other out, but good God, when does Tyler sleep?

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4 Anon March 12, 2017 at 6:03 am

Aren’t many of these posts pre-written and auto-released?

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5 Yancey Ward March 12, 2017 at 3:04 am

I would simply call it a malinvestment in government.

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6 mulp March 12, 2017 at 4:46 am

If government borrowed less and paid money to individuals with no or very little money, the demand would fall more, which would put further downward pressure on prices.

Either individuals would starve, like in say Sudan, where there basically is no government, or individuals would be forced to squat and produce and barter, say in areas people are encroaching on public lands, or in the squats outside cities. In any case, nationally, they do not contribute to national gdp in either production or paying for gdp.

The only time I know of that corporations acted as if supply side economics made any sense was in the 70s when businesses produced more every quarter no matter what. That ended badly when they ran out of warehouses for everything not sold.

Today, production does not happen unless someone is 95% certain to pay for it. So, given the working poor likely won’t pay, nothing is produced. Thus the working poor remain poor. Tax revenues stay flat or go down. Thus investment goes down, infrastructure deteriorates, the wealthy leave, crime goods up, consumption by government locking people up increases.. as well as dealing with drug overdoses and shootings. And given no body pays except maybe government, it’s not counted as production even though lots of labor in expended. Nor is anything of value produced.

Keynes argued that the last resort is government paying workers to build productive capital assets.

But I bet you think there are too many roads, too many water and sewer, too many power lines. Until you are stuck in traffic, or you have no water or the sewer backs up into your basement, or the power goes out for 3 days. All of a sudden,, you demand government fix it.

Why don’t you pay workers to build good public investments. Fix the roads that are congested with your own money. Thus both workers paid driving up wages, thus demand driving up prices, increasing traffic and congestion so you can spend your money making good investments in roads.

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7 msgkings March 12, 2017 at 3:07 am

Very solid post, thought provoked.

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8 cowboydroid March 12, 2017 at 3:26 am

I can’t tell… Is this a descriptive account, or prescriptive policy advice?

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9 Trevor Adcock March 12, 2017 at 4:15 am

How is this a theory of the business cycle it is a theory of fluctuations in investment and consumption. It does not protect itself from the criticisms of the Austrian Business Cycle. Instead I often feel Tyler just believes that “Great Men” must have had something useful to say to us. Even if they were full of it.

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10 Millian March 12, 2017 at 5:56 am

That is the non-Straussian reading of Straussians.

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11 rayward March 12, 2017 at 7:27 am

The variable is asset prices, the corrective is a plunge in asset prices. That’s the Austrian “solution” to the misallocation problem. Cowen is too smart to come right out and promote what critics call “depression economics”, but some of his less politically astute colleagues are not. You want disruption? Let asset prices plunge and see what happens. Cowen frames the choice as between makers (investors) and takers (you know who they are), but the so-called makers have the most to lose when asset prices plunge. What they prefer are stable asset prices (propped up by government intervention in markets) and a plunging labor share. Bubbles are the result of too much wealth concentrated in too few makers; plunging asset prices solves both of those “problems”.

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12 The Anti-Gnostic March 12, 2017 at 12:03 pm

Bubbles are the result of too much wealth concentrated in too few makers; plunging asset prices solves both of those “problems”.

I would define a “bubble” as speculative bidding on assets beyond the point of financial reality, like the assumption by investors beginning around 2000 that housing prices would just increase forever. Dutch tulip bulbs, Florida swampland, tech stocks have all been the object of these bouts of irrationality. As you seem to perceive, reality is the corrective: prices should reflect the underlying fundamentals, not what will keep Goldman Sachs solvent. Asset prices fall, wealth is transferred from spendthrifts to the more level-headed, capital is re-deployed into sustainable activities.

If the Austrian model is “depression economics,” I guess the Keynesian model is “foam-padding-and-opioid-drip economics.” No pain, no pain!

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13 Boonton March 12, 2017 at 7:39 am

“There are also some constraints of borrowing. ”

I think this is the key point. I doubt any large developed economy has yet borrowed to its constraints. The model of the gov’t expanding or contracting the deficit to win votes by giving out ‘goodies’ is likewise not very clear. Wouldn’t our politics be far less partisan if that model worked? If, say, Obama could have won over some Republicans by increasing crop subsidies or such?

Also do deficits reward short term consumers and austerity rewards savers? Upper income tax breaks, for example, do not seem to obviously reward consumers to me as much as savers. Ditto for many Republican tax cut ideas.

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14 Matt Young March 12, 2017 at 7:40 am

Great, the pro-cyclical story of fiscal policy. Let us quantize that in units of electoral states. What we see, every eight years is so, is a switch from California dominance to Texas dominance of the politics in the Swamp. The election of Trump is he exception to the rule. New York and the North East are dying as the cost of flipping efec them the most. New York used to be the consistent political ruler, a dominance gone with the westward migration. As Texas and California get bigger and bigger, the flips get more violent until secession is the only solution.

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15 Matthew Young March 12, 2017 at 7:49 am

I should note the triggering cause ofthe American civil war was California and Texas entering the union, and John Fremont, the anti-Mexican, went to DC as a Senator and founded the radical republican party, pre-lincoln. The plot was federal subsidies for westward expansion, and the level of socialism implied would have required a settlement of the slave issue.

This issue of counter cyclical policy and relative state size has been, in the semantics of the day, the first or second issue facing constitutional framers, since day one. It never went away. It has always been the cause of violent strife and civil war.

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16 Matt Young March 12, 2017 at 8:04 am

As a Californian this is a dear issue. California, Baja and Alta, were for almost two hundred years a separate nation, founded by a religious order in the second colonial era, separate fro old Mexico. From the tip of Baja to Sausalito, the Franciscan system of economic flourished. And the church, informally kept its role up until the dust bowl and WW2.

Our entire culture is still, to this day, dominate by a unique, native nation. Tijuana and San Diego now an enseperable metropolis. You have to be careful in understanding California, a large group of us are both, not-Mexico and not-DC; we are the natives, so to speak, the pre-dust bowl crowd. The political and economic structures out here, all defined by the Franciscans.

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17 Matthew Young March 12, 2017 at 8:24 am

Allow me, my hearts a thumping.
When Fremont and pals booted the Mexicans, what was left? A national university system, likely the best in the world, and it still exists and still vies for best in the world. The Franciscans dunnit, along with a federated city type of governance, with connection roads, school system, markets. Political and legal rule was local, “Go take it up with the priest”. Given the subsequent civil war, back east, one could very well claim the Fransiscans had the more advance civilization.
I long for the re-unification of Baja and Alta; and no, we are not Northern Mexico, we were never Mexico.

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18 Matthew Young March 12, 2017 at 9:09 am

Don’t stop me please!

How did the US end up with a nationwide Catholic school system shortly after the civil war? Imported from European immigrants? Nope, California born and bred. The Franciscans are the work horse organizers in the church, and what they did in California over the 200 year period became the road map (in education, it was a global modernization). California had the national grammar school education before the politicians in DC knew what was up. The California university system under the church became the model for the UC system, Lincoln bought into the vision Fremont saw in California, hence the national state grant system. In a way, California won, the original California.

19 Boonton March 12, 2017 at 8:57 am

Sounds good but in the Civil War era both north and south had two mutually exclusive but intellectually coherent views on how the US should be ordered. You could say slavery was immoral but it was a coherent economic and political system.

Does the right have such a view today? The march to Trump has also been a march away from conservatism as an ideology and more as a fashion, and a transitory one at that. If Texas leads a march to secession exactly what are they going to succeed at being, esp. as Texas’s white population gets older as time goes on.

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20 Taylor Rule March 12, 2017 at 10:37 am

“Imagine a government that is perpetually in debt, and with voters who do not like new taxes, if you can stretch your mind that far.”

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21 rayward March 12, 2017 at 10:53 am

And I thought the Austrians looked to Plato as their guide. How about Making Athens Great Again. https://www.theatlantic.com/magazine/archive/2017/04/making-athens-great-again/517791/

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22 Ben March 12, 2017 at 11:54 pm

The author forgets that a certain student of Aristotle went on to conquer the known world a few decades later, and that Plato was writing in the Golden Age of Greek intellectual thought. Its true that the Delian League never recovered, but Greek power on the whole was clearly ascendent until at least Alexander.

And Socrates was about to receive a pardon until he trolled the jury with demand for free food for life. Was Socrates stupid and impulsive, or was something else afoot?

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23 Some Guy March 12, 2017 at 11:19 am

Whenever you see the modifier “neo” it is safe to assume that what it is modifying is worn out, exhausted, and ready to be discarded.

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24 Rags March 12, 2017 at 12:14 pm

Long term rates of taxation and spending (as a percentage of GDP) are remarkably stable. This neo-Austrian theory arises from that. It is an interesting perspective on a long term trend. You also remind us that spending has become less discretionary over time.

So we either get: A) an increasingly rigid sameness, B) similar tax with revamped spending, or C) revamped everything?

Option A has been strong, shows no real sign of weakness.

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25 Ray Lopez March 12, 2017 at 12:26 pm

Given money is largely neutral, there’s a lot of assumptions build into this post by TC, but I will criticize his grammar here: (TC) “Imagine a government that is perpetually in debt, and with voters who do not like new taxes, if you can stretch your mind that far.  There are also some constraints of borrowing.  The fiscal policy of this government THUS is relatively active when interest rates are low, but contractionary when interest rates are high.” (emphasis added).

In no way should “thus” be used in the above, it simply confuses rather than clarifies. Drop the “thus” and the passage is more understandable.

Bonus trivia: reading David A. Stockman’s “The Triumph of Politics”, a classic. The small government idealist Stockman runs into the buzz saw of populist politics comprised of Mike Deaver, Ed Meese, Jim Baker, Lyn Nofzinger and last but not least, the underrated President’s confidential secretary, Helene von Damm (Austrian ambassador four times married, damn! you don’t hear about her that much do you?). Sample sentence about the above, especially Deaver: “They had gone into another one of their overnight panics. … That was how they operated. Reality happened once a day on the evening news. They were now going to kill last night’s ‘bad story'” [Stockman’s Atlantic story with Greider]. Sounds familiar, like Trump’s alternative universe fueled by social media.

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26 rayward March 12, 2017 at 1:08 pm

In Cowen’s book he writes that Americans are opposed to redistribution, African Americans especially. Now on his blog he writes that Americans are seduced by the goodies that government doles out. In the American trial lawyer tradition, I ask: which is it, the truth Cowen writes in his book or the truth Cowen writes in this blog?

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27 The Anti-Gnostic March 12, 2017 at 1:45 pm

Speaking for myself, I’d like a government so small it doesn’t matter who’s in charge of it. I’ve been told that’s impossible; racist in fact. Remember Lindsey Graham yelling at libertarians that the GOP would not be the party of angry white guys?

So I’ll take option two: my tribe wins and gets to run things.

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28 rayward March 12, 2017 at 2:46 pm

In the American trial lawyer tradition, you don’t answer my question. Touche. Since you also responded to my comment about asset prices, I would point out that in his book Cowen is optimistic that, despite all the complacency, better days lie ahead. After the “reset”. What reset? He doesn’t say. Cowen is a very savvy guy, and I admire him for it. At a different thread I asked if the “reset” will be so bad that we should sell the farm and follow Cowen’s friend Peter Thiel and move to New Zealand. Has Cowen purchased a place in New Zealand? Has Thiel offered him a place to stay? How long will the “reset” last? Should I purchase a year’s supply of bottled water? Canned beans?

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29 Chris Wegener March 12, 2017 at 2:34 pm

It seems that the shift inn economics from theory to econometrics has largely bypassed Mr. Cowen and other libertarians/Austrian economists.

There is nothing in the real world which corresponds to the events discussed in this article. The danger described by the Austrian/libertarians has always been that the government would over extend itself by pandering to the poor and give away the store through social programs.

What has happened, the government has been captured by the wealthy and the destruction of the tax system and redistribution to the wealthy. We have an explosion of debt because we do not collect enough in taxes and we spend far too much on our military and the large corporations that suck on the public teat. Attention to this problem is diverted by false claims that we are impoverishing our children by giving out food stamps and welfare. Until Mr. Cowen and others seriously discuss the issues, we as a country, face the prescriptions he proposes are nonsense.

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30 rayward March 12, 2017 at 3:00 pm

But the apocalypse awaits. For some, the lesson of the 1930s and 1940s can be found in the writings and philosophy of Leo Strauss. For me, I find it in the writings and philosophy of Dietrich Bonhoeffer. Of course, Bonhoeffer was murdered by the Germans, Strauss wasn’t.

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31 Ben March 12, 2017 at 11:58 pm

And what a beneficial shift to econometrics its been. I mean, look at how brilliantly they handled the bailouts. We had all sorts of very fancy equations telling us to give Bernanke’s compatriots 1t+ in public money, all proven by econometrics with as much merit as empirical work in physics, chemistry, and biology.

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33 Michael March 13, 2017 at 9:40 pm

This was very interesting, but… question:

“The fiscal policy of this government thus is relatively active when interest rates are low, but contractionary when interest rates are high. When interest payments eat up a smaller share of the federal budget, more goodies are given out.”

Is this (inverse association between government spending and interest rates) true in practice?

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