Paul Krugman on Austrian trade cycle theory

Here’s the problem: As a matter of simple arithmetic, total spending in
the economy is necessarily equal to total income (every sale is also a
purchase, and vice versa). So if people decide to spend less on
investment goods, doesn’t that mean that they must be deciding to spend
more on consumption goods–implying that an investment slump should
always be accompanied by a corresponding consumption boom? And if so
why should there be a rise in unemployment?

Here is the link once again.  But I think the point is more effective in reverse.  Why should the boom be a boom in the first place?  The shift toward investment goods, and thus away from consumption goods production, should mean falling real wages, not rising real wages.  In other words, the Austrian theory doesn’t generate the very high degree of comovement found in the data.  Or, in other words, there aren’t that many countercyclical assets.

One MR commentator suggests this, this, and this as responses.  They make various points against Krugman (who I might add is not as clear as usual in this piece) but they don’t solve this central problem of generating the amount of comovement found in the data.  The best shot is to relax the Austrian-favored methodological assumption of full employment; I leave it as an exercise for the reader whether that could work and what other problems for the theory it might create. 

I should add that Gordon Tullock has made much the same point, as has Bob Lucas or for that matter Piero Sraffa in 1932.


Comments for this post are closed