Reconciling Hayek’s and Keynes Views of Recessions

There is a new NBER paper by Paul BeaudryDana Galizia and Franck Portier and perhaps it may apply to China:

Recessions often happen after periods of rapid accumulation of houses, consumer durables and business capital. This observation has led some economists, most notably Friedrich Hayek, to conclude that recessions mainly reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending should not be used to mitigate such a liquidation process, as doing so would simply result in a needed adjustment being postponed. In contrast, ever since the work of Keynes, many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy. In this paper we reexamine the liquidation perspective of recessions in a setup where prices are flexible but where not all trades are coordinated by centralized markets. We show why and how liquidations can produce periods where the economy functions particularly inefficiently, with many socially desirable trades between individuals remaining unexploited when the economy inherits too many capital goods. In this sense, our model illustrates how liquidations can cause recessions characterized by deficient aggregate demand and accordingly suggests that Keynes’ and Hayek’s views of recessions may be much more closely linked than previously recognized. In our framework, interventions aimed at stimulating aggregate demand face the trade-off emphasized by Hayek whereby current stimulus mainly postpones the adjustment process and therefore prolongs the recessions. However, when examining this trade-off, we find that some stimulative policies may nevertheless remain desirable even if they postpone a recovery.

There is another copy here.

Comments

The economy is booming despite the Obama stimulus being a failure, even to the democrats. It's not that the government shouldn't be used to mitigate recession or that it cannot mitigate recession, but the present economic boom had other tailwinds that made the Obama stimulus ineffective and unnecessary.

The economy is booming? we have the lowest labor force participation in decades

some data such as low labor force participation, low yields, and risk aversion may seem recessionary

other data isn't. http://tinyurl.com/ewffefwww

In weighing the bullish and bearish and bullish data, the bulls seem to have the upper hand. GDP growth has returned to pre-2008 levels, for example.

http://cosmoscon.files.wordpress.com/2012/04/gdp-since-1930.jpg

"GDP growth has returned to pre-2008 levels, for example."

You mean the 0.1% GDP growth from Q1 2014?

I mean it's not the necessarily the most accurate metric, but it is the one you proposed to justify "booming".

Or do you mean 0.8% contraction? http://blogs.wsj.com/economics/2014/05/13/u-s-economy-contracted-in-first-quarter-latest-figures-show/

BOOMING!

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NO, NO, NO.

The level of real GDP has surpassed the 2008 peak level of output.

But that says little or nothing about the growth rate.

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Can we get a little further past the prior peak before we call it a boom?

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Is it just me, or does this abstract suggest a Hegelian synthesis? That doesn't make it right, but it might make it a viable policy framework.

It's just you.

Hayek and Keynes views of recessions can NOT be reconciled,

Keynes was fundamentally wrong on the causes & cures.
Mises & Hayek had it right, but that critical economic lesson has been ignored now.

Productive human learning is optional; human survival is also optional.

(P.S. -- correct term is malinvestment, not overinvestment)

Mises ? He of not subject to verification or falsification on the ground of experience and facts ???

Is a principle like "Opportunity Cost" open to falsification? It's as true as it is deductively, so maybe there could be a problem with the logic of it, but it does not really seem open to falsification empirically.

The fact that Mises holds that his theory of the business cycle is immune to "experience and facts" makes is PSEUDOSCIENCE.

And anybody who buys into pseudoscience is an ignorant who shouldn't have any sort of strong opinion on economics.

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I'd have to ask that you supply some citation to support your claim that Mises believed that his theory of business cycles, specifically, was impervious to contradictory evidence, because it strikes me as implausible and I have some cursory familiarity with, but not perfect memory of, his writing on the subject.

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Its statements and propositions are not derived from experience. They are, like those of logic and mathematics, a priori. They are not subject to verification and falsification on the ground of experience and facts. They are both logically and temporally antecedent to any comprehension of historical facts.

If that isn't pseudoscientific bullshit, I don't know what is.

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Again, I would say that this would apply to a basic principle like opportunity cost, and the context of your reference is his speaking of such basic principles. Still waiting for your evidence in whether this applies entirely to his views on the business cycle, which would be at the end of a long chain of reasoning involving reference both to basic principles and to facts, observations, etc.

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Can't tell if you're stupid, trolling or lazy.

That is what Mises had to say about his business cycle theories. He said so himself.

http://socialdemocracy21stcentury.blogspot.ro/2010/10/mises-praxeology-critique.html

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Did you read your own link? There is no reference to Mises' views of business cycles therein, but again, his views on the foundations of economic thinking, and that it was primarily deductive (unlike, say chemistry).

While the article you've linked to is certainly critical of Mises views as they are, it acknowledges the exact point I initially made, saying:
"Cleary even Mises himself admitted that synthetic propositions as auxiliary hypotheses entered into his praxeological deductive reasoning. If such assumptions do not correspond to the “real conditions of the external world,” then his inferences are unsound and untrue."

In case you're wondering, or assuming, whether I'm going to the mat for Mises views--I'm not. But I'm sympathetic to his view that deduction plays an important role in establishing economic principles, and that it's simply a categorical mistake to treat the study of human action as if it were something like chemistry. You, however, are making arguments that are evident to me to be based on a very flimsy understanding of what Mises was arguing at all. Peace out.

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What I'm saying is that praxeology is pseudo-science. When you exempt your theory from empirical validation, you're not doing science. Which is what Mises (and his followers) did.

End of story.

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Holy Christ, praxeology isn't a theory, it's a method of inquiry. Calling it pseudoscience is like calling science itself a pseudoscience.

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Nitpick all you want, the fact remains that praxeology is quasi-religious bullshit. And so are the conclusions drawn using it.

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""the fact remains that praxeology is quasi-religious bullshit. And so are the conclusions drawn using it.""

Unlike praxeology, this is a perfect example of pseudoscience.

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You don't really understand how this whole "science" thing works, do you ?

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I do. You're the one that struggles with it, or at least doesn't understand it's limitation. For example, I understand that in order for the scientific method to yield accurate predictions, the object being studied can't alter it's behavior based on the theories the scientists puts forth. Since human beings do in fact change their behavior based on the theories they operate under, this makes doing science in the humanities next to impossible, and opens the door to other methods of inquiry.

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Hayek, via Mark Perry:

In modern times, this argument stresses rule by a wise guild of “scientific experts” especially endowed in knowledge of statesmanship and the arcane facts of the world. The increasing use of scientific jargon, especially in the social sciences, has permitted intellectuals to weave apologia for State rule which rival the ancient priestcraft in obscurantism. For example, a thief who presumed to justify his theft by saying that he was really helping his victims by his spending, thus giving retail trade a needed boost, would be hooted down without delay. But when this same theory is clothed in Keynesian mathematical equations and impressive references to the “multiplier effect,” it carries far more conviction with a bamboozled public.

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It's one thing to use deductive reasoning.

It's a whole different thing to exempt your theories from facts - that's what makes it pseudoscience.

But then again, I'm arguing with morons here.

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They are closer than people think. Keynes didn't really care about the causes and called that a feature. People think Austrians don't care about the solution but the government should have started doing nothing a long time ago. My view is the government claims authority over money and credit (and fiscal policy) so until that changes they need to get it right Sumner has some interesting posts on this recently.

y view is the government claims authority over money and credit (and fiscal policy)

Government claims authority over LEGAL TENDER. As it should be.

That government exerts authority over what is used as money is entirely arbitrary. And kind of irrelevant. If the government declared elephant poop legal tender, it wouldn't make it money. When Zimbabwe declares its printed paper "legal tender," it's still practically useless as money.

As long as you have government, you have taxes. As long as you have taxes, you have legal tender.

Therefore, it is government's duty to properly manage legal tender.

The rest is obscurantist bullshit.

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Can you pay taxes in elephant bullshit? Can you pay taxes in gold? How about livestock?

Can you carry elephant bull shit in your wallet? How about legs of lamb?

As you can see, legal tender = money because of convenience. The choice as to what is to become legal tender, and therefore money, is clearly not arbitrary.

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If you don't pay your taxes and you're sitting on a pile of gold coins, the government will gladly take those gold coins in satisfaction its lien. My point is that ultimately the market decides what is money, and what the government declares legal tender is beside the point.

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My point is that ultimately the market decides what is money, and what the government declares legal tender is beside the point.

Apparently, the market has decided that it's happy to use the government's legal tender as money.

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""Apparently, the market has decided that it’s happy to use the government’s legal tender as money.""

Sure it has, but only because the government's legal tender allows the money handlers to socialize their losses onto everybody else.

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government’s legal tender allows the money handlers to socialize their losses onto everybody else.

Does that even mean anything or are you just using some sort of automatic Austrian bullshit generator ?

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Calm down, psychopath. All it means is that a monopolized currency behaves like a public good, and the effects that a bank has on it are borne by everybody, not just the customers at that bank.

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I should know better than to try to reason with someone stupid enough to buy into Austrian pseudo-science.

Yes, legal tender is a public good - and should be managed accordingly.

So ?

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So? So you asked why the market has chosen the government's tender, and I told you...it's because they can socialize their losses.

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edit: you didn't ask, you just stated it...and I told you why that was so.

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You really are dumb.

So people are happy to use government issued dollars because moral hazard has been institutionalized in the banking sector ?

That doesn't even begin to make sense - but then again, I haven't drunk Austrian Kool-Aid.

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real gdp growth over the last 5 years;
1.57%
2.03%
2.27%
1.32%
2.33%
========
1.90 % average

In the five years before the recession growth average 2.72%

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Let's assume, arguendo, that both the assumptions and conclusions of this paper are correct.

While fiscal stimulus might be the most efficient way out of the problem, what incentives does it provide ex post? The stimulus almost invariably rewards the very people who deserve punishment for bad choices.

By engaging in stimulus, you are ratifying the actions that produced the recession AND reinforcing expectations for the next boom/bust cycle. In the worst case, malinvestment from palliative fiscal or monetary policy might actually cause the next boom/bust cycle, in real terms rather than merely manipulating expectations.

This is exactly my view. The best way to get out of a recession is to never get into one.

That these cycles are driven by durable goods is not coincidental. Because they are long lived assets, they displace demand for the output and associated inputs for decades. A carpenter builds his own coffin. Nondurables and services, which vanish upon consumption, refresh their own demand.

The displacement in time of resource demand is most serious for labor because labor and its progeny have to eat, but durable components can be stored or repurposed more easily. If we could cryogenically freeze workers in these industries until the overhang of durables is resolved, the sticky wage and unemployment problems would vanish.

Unfortunately, this is not a viable option for reasons that should be obvious. I leave the proof as an exercise for the reader.

While fiscal stimulus might be the most efficient way out of the problem

Except that the fiscal multiplier is ZERO when the central bank targets inflation. So fiscal stimulus does NOTHING. No, actually is does something - it adds to the national debt.

the very people who deserve punishment for bad choices.

Like the people who are out of jobs because the central bank allowed aggregate demand to collapse ?

By engaging in stimulus, you are ratifying the actions that produced the recession AND reinforcing expectations for the next boom/bust cycle.

By eating, you will only postpone the inevitable - you will be hungry again tomorrow.

malinvestment

Because the entrepreneur is the engine of progress AND a moron. At the same time.

That these cycles are driven by durable goods is not coincidental

You are a moron. Correlation does not imply causation. Also, there was no housing boom.

http://thefaintofheart.files.wordpress.com/2013/07/excuses-galore_3.png

Nondurables and services [...] refresh their own demand.

So aggregate demand comes out of thin air ?

the sticky wage and unemployment problems would vanish.

Those stupid humans, how dare they behave differently than Mises wanted them to ?

------

My conclusion is that joining the Austrian cult requires ignorance and/or stupidity.

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From The Party Culture War by Steve Johnson.:

[John Maynard] Keynes was also openly homosexual, and he recorded many of his same-sex encounters in the diaries that he kept. Two of his great loves were the artist Duncan Grant and writer Lytton Strachey, the latter of whom described Keynes as "a liberal and a sodomite, an atheist and a statistician." He married a Russian ballerina in 1925, but he maintained a relationship with a younger man during the courtship.

Keynes's particular depravity appears to have been pedophilia. He and his homosexual friends often went to resorts along the Mediterranean Sea, where little boys were sold to bordellos by their parents. He took advantage of the bitter poverty he witnessed in North Africa, Italy, and the Middle East and purchased male child prostitutes for English shillings. In his communications, he advised his friends to go to Tunis, "Where 'bed and boy' were also not expensive.

From Keynes: A Critical Life by David Felix

[Keynes] advised Lytton, who was going on a holiday to Tunis and Sicily, on modalities "if you want to go where the naked boys dance." Responding to his friend's scatological taste, he closed with the lines from a poem: "We paid our suit to Janus/ Mistook the one mouth for the other anus." He himself was going to join an old classmate, now a colonial officer there: "I'm leaving for Egypt. . . . I just learned that 'bed and boy' is prepared."

yeah, because his sexuality has a lot to do with his economic policies. good catch.

As a childless homosexual, he would have higher time-preference. It makes sense to pull future production forward to pay for present consumption because we'll all be dead in the future.

Though interestingly, Keynes ultimately married. His wife miscarried, sadly.

It makes sense to pull future production forward to pay for present consumption because we’ll all be dead in the future.

Except that he never argued in favour of such a thing.

Apparently, any mention of Keynes/Mises/Hayek brings the austro-nutjobs out of the woordwork.

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Trolling against Keynes nonewithstanding, the paper seems meh... what is even more funny is that the guys did not even take the time to actually read Keynes and Hayek (look at the references), used some popular book to motivate the facts, and modified some run-of-the-mill New Keynesian model. Honestly, we should ask more of these self-proclaimed scholars. Economics is much more than applied math to BS.

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What is this bullshit ?

Back in the real world, the good ol' sticky wages model still provides a pretty damn good explanation of business cycles.

Do people get paid to write crap like that ?

Friedrich Hayek, to conclude that recessions mainly reflect periods of needed liquidation resulting from past over-investment

Ah yes, economics like a morality play. "You have sinned in the past and now you must face punishment"

many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy.

Except that the fiscal multiplier is ZERO when the central bank is given a nominal target (like inflation, for example)

In our framework, interventions aimed at stimulating aggregate demand face the trade-off emphasized by Hayek whereby current stimulus mainly postpones the adjustment process and therefore prolongs the recessions.

What planet do these people live on ? Because back on Earth, monetary stimulus ENDS RECESSIONS.

Truly macroeconomics is in a dark age when this sort of crap gets attention.

A Paul Krugman true believer?

Is this trolling? Sometimes this site is so sublime.

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You must be retarded. I say this in full seriousness and not as an insult.

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I've come to believe that this point of view is the most empirical. Too many economists mistake correlation for causation and engage in post hoc rationalizations. We must be bold and go where the evidence takes us. No more feelingsnomics please.

Isn't "going where the evidence takes us" just a different way of saying "mistaking correlation for causation and making post hoc rationalizations"? The fact is that you can't get evidence without using some theory to gather and interpret the evidence, so it's silly to imply that we can have a purely empirical approach to economics with theory being derived from evidence.

The point was that Austrian Business Cycle Theory is pseudoscience.

And Keynes's only original idea - that of the "liquidity trap" which supposedly occurs when interest rates hit zero, which makes monetary policy impotent and requires fiscal stimulus - is bullshit. It may be true on a gold standard, but on fiat money it simply does not apply.

So when you attempt to reconcile two idiocies ... you get a third idiocy.

Truly macroeconomics is in a dark age.

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I find it sad that you believe this. Currently economists refuse to go where the evidence takes them. They make predictions about things. Then they gather the evidence. Then they ignore or dismiss the evidence. Like all those economists who predicted massive inflation 4 years ago and were wrong. Or all those economists who signed off on that Rogoff fraud. But I'm probably wasting my time trying to explain concepts like falsification and verification to you.

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Since when is government stimulus in the same areas as over investment? Quite a stretch.

Hayek never had a theory of recessions, we were all at full employment by his assumption.

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I must say i find this interesting and have had similar thoughts. However, i don't think stimulus has to be counter productive and can help recovery. Keynes insight was everyone cant save and pay down debt at the same time and prices are sticky so adjustment takes time. My expenditures are your income, etc. he isn't concerned with why this happens. Enter the over investment process. I think china fits this description. Suppose now the minsky moment occurs and deleverag begins and you have millions of people sitting around doing nothing. Why is it counter productive to put those people to work building infrastructure when the borrowing costs are so cheap? Not all investment is bad just some. Investing in roads or basic science or many other types of things don't prevent adjustment. It just quarantines it from affecting healthy areas of the economy.

If the central bank is given a nominal target (like inflation), what is the value of the fiscal multiplier ?

Hint - it starts with "Z" and ends with "ERO".

If the central bank has a nominal target of 2%, which it has consistently undershot, why do you think they would contract before hitting the target? If you really take the nominal target seriously, then you believe the Fed wouldn't do anything to offset fiscal stimulus until inflation doubles from the QE level, so fiscal stimulus would work.

Do you believe in what people say or in what people do ? If you see somebody claim they want to lose weight, yet stuff themselves at every opportunity ... it's more than obvious that losing weight is not on their actual agenda.

Similarly, if the Fed claims a target of 2% inflation yet CONSISTENTLY stops short ... it simply means that their REAL target is lower and their public statements are bullshit.

the Fed wouldn’t do anything to offset fiscal stimulus

Except the Fed has consistenly sabotaged fiscal stimulus.

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Even if the multiplier is small, though that is far from clear at very low rates, the millions of people unemployed have more to spend than they otherwise would have and we get a new highway system out of it, or put a man on mars, or a high speed rail network, or whatever. I fail to see how that is a bad idea in times of mass unemployment and low borrowing costs. Maybe we should rethink where to spend the money but i doubt its counter productive or somehow preventing adjustment.

You don't really understand much, do you ?

The whole point of fiscal stimulus is to raise aggregate demand. In practice, that means a rise in inflation (among others).

If the central bank is given an inflation target, it would respond to fiscal stimulus by tightening money - effectively canceling it. The effect on unemployment would be zero.

In related news - please abstain from commenting on economics. You clearly have no idea what you're talking out.

*about

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How long has inflation been below target now?

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^ my point exactly

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Oh I see you have addressed this already. The fed has secretly deviated from decades of targeting 2% all in the middle of the worst recession in a century. Call me incompetent, but I find that less than very convincing.

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Call me incompetent, but I find that less than very convincing

The alternative being that the printing presses are out of order. Which is EVEN LESS CONVINCING.

Keynesian bullshit has been falsified over and over. Fiscal stimulus is ZERO, monetary policy is what decides macroeconomics performance, Japan has been proving it over and over for the past two decades.

Grow a brain and accept reality.

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I think you have a case of read the evidence you like, pretend what you don't like doesn't exist. Try reading empirical literature on this the multiplier and have the sac to open your eyes when you do so.

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^ Serves me right for trying to reason with idiots.

http://modeledbehavior.com/2012/05/18/the-sumner-critique-and-the-central-bank-multiplier/

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Some more reading

http://www.basilhalperin.com/blog/2013/08/simple-model-demonstrating-sumner-critique/

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It's pretty obvious you have read your sumner. Now try broadening your horizons a bit.

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If having a "broad horizon" means believing that printing money doesn't cause inflation, or coming up with macro models where the central bank's reactions are completely ignored - then I'd rather stay narrow-minded.

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Printing money doesn't cause inflation, otherwise we'd have had higher levels of inflation over the past 5 years. Printing money and buying stuff causes inflation. The Fed did it's part, fiscal stimulus would have taken care of the buying stuff part. Of course you seem to believe that whatever level of inflation was achieved is what the fed desired, so there is no debating someone who believes in a theory that can't be proved wrong.

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Of course you seem to believe that whatever level of inflation was achieved is what the fed desired

That is absolutely correct. The Fed has absolute power over aggregate demand. Only an obscurantist would argue otherwise.

Of course, plenty of times they choose not to exercise their power. Mainly due to mental blocks. Like yours.

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It's pointless to argue against a Sumner disciple since his entire theory is and always will be an article of faith, but since the people making decisions at the Fed don't agree that they are omnipotent, they don't act as you (or Sumner) think they should, so your claim about what happens when they act as you think they should don't matter.

In the real world, where the people running the Fed seem to think using monetary policy to hit their inflation target is either too risky or pointless, fiscal stimulus likely wouldn't be offset by monetary policy until inflation reaches their target.

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the people running the Fed seem to think using monetary policy to hit their inflation target is either too risky or pointless

Are you so stupid you don't even realize you're agreeing with me ?

They don't say they CAN'T hit their inflation targeting, they're saying they WON'T (and then they're rationalizing why not). Are really so dumb you can't tell the difference ?

And yes, there's no point in arguing with a Sumner disciple, because Sumner is 100% right on this.

And long as you own the printing presses, the sky's the limit. Not that you'd want to go there.

And the fact that they're refusing to hit their target is, in my view, tantamount to treason.

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This might come across as a silly comment but it's not intended to be. Speaking as a non-economist, is there anything to show that government statistics are (more or less) reliable in terms of the source data, especially over time? I seem to recall an article once showing that the world has a trade deficit with itself.

More specifically, when I worked for a company I had to complete periodic surveys from the government asking for info such as annual sales, payroll etc. It's been a while & I don't remember the agency or exactly what it wanted. I made up the numbers, partly because I didn't have time to track them down in the format required but mostly because I don't believe in governments having any more information than can be helped.

Has anyone ever tried to examine whether the info used in discussions like this is somewhat reliable or does everyone just assume it is and go from there?

It's. pretty reliable. If it was pure crap people would know. How could the world have a trade deficit with itself? You have to trade with someone right? How can there be either a deficit or surplus at a global level? Think about that.

Well, I may have been thinking of this - though I'm pretty sure it was something much more recent - but your argument is somewhat circular.

http://www.hks.harvard.edu/fs/jfrankel/TradeWithOtherPlanets.pdf

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that recessions mainly reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending should not be used to mitigate such a liquidation process, as doing so would simply result in a needed adjustment being postponed.

I'm not seeing how these two ideas ever connected. OK, so some people borrowed too much in 2007 and brought houses for far too much. So what? Think of all the stimulus that was done. How would it help?

Lower interest rates? Doesn't help the guy whose under water on his mortgage. Is great, though, for someone who didn't get caught up in the boom.

Infrastructure projects? Unless you happen to be in a profession that lines up exactly with gov't contracts,it's not clear to me how this helps you avoid foreclosure on your upside down house.

Unemployment extensions, payroll tax cuts, etc.... Again this may help preserve your income but it doesn't seem to prevent liquidation of your poor decisions.

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That sounds very interesting! The one quibble I have is with the word "over-investment." Hayek's is a malinvestment theory of the business cycle, not an over-investment theory.

I think Hayekians need to be more clear about the difference between the two. If too many people buy pizza ovens because they overestimate how many pizza shops the economy can support, is that over-investment or mal-investment?

That would be mal-investment. Over-investment in the Hayekian sense would be a general overinvestment, IE the total amount invested in the economy is "too much."

The concept of mal-investment as cause of recessions never made an ounce of sense to me

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So 'too much' investment would cause the return on investment to fall. That would mean a person with savings would be more inclined to consume it rather than save or invest it.

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