WEBVTT NOTE Business Cycle Theories: Symptoms v. Causes 1 00:00:00.000 --> 00:00:04.000 My talk is Business Cycle Theories, Symptoms vs Causes. 2 00:00:04.000 --> 00:00:10.000 There are a plethora of explanations and solutions from the various schools of economics to the boom bust cycles. 3 00:00:10.000 --> 00:00:13.000 Each of the various theories proposes a cause. 4 00:00:13.000 --> 00:00:17.000 What was the event or action that causes the boom bust cycle? 5 00:00:17.000 --> 00:00:20.000 Furthermore, each of the theories also provides a cure. 6 00:00:20.000 --> 00:00:23.000 What can be done to alleviate boom bust cycles? 7 00:00:23.000 --> 00:00:26.000 Each of the business cycle theories are at odds with one another, 8 00:00:26.000 --> 00:00:29.000 proposing different causes and thereby different cures. 9 00:00:29.000 --> 00:00:36.080 Cures. In essence, each theory is in conflict with one another. Obviously, this audience 10 00:00:36.080 --> 00:00:40.360 knows which business cycle theory describes the Boehm-Bawerk cycle most accurately and 11 00:00:40.360 --> 00:00:46.640 correctly, namely, the Austrian Business Cycle Theory, developed by Ludwig von Mises, pushed 12 00:00:46.640 --> 00:00:52.000 forward by F. A. Hayek. Although there are methodological differences between the various 13 00:00:52.000 --> 00:00:56.400 schools of thought, I propose that many of the other business cycle theories are in one 14 00:00:56.400 --> 00:01:11.400 The theories aren't correct in that they are able to identify symptoms. However, these theories are detrimentally wrong because they could not identify the root cause, thus proposing the wrong cure. 15 00:01:11.400 --> 00:01:20.400 The business cycle theories we are examining are associated with the following economists. 16 00:01:20.400 --> 00:01:27.120 F. A. Hayek of the Austrian School, of which Hayek won the Nobel Prize, Milton Friedman 17 00:01:27.120 --> 00:01:33.800 of the Chicago School, Hyman Minsky, who has come out of nowhere as of late, our next speaker 18 00:01:33.800 --> 00:01:39.400 will delve into the details of Minsky, and undoubtedly our favorite economist of all, 19 00:01:39.400 --> 00:01:45.880 last and certainly least, John Maynard Keynes. 20 00:01:45.880 --> 00:01:50.280 With each of these economists, we will examine the following. We will touch on how each economist 21 00:01:50.280 --> 00:01:53.280 Hayek once proposed that the economy produces sustainable growth. 22 00:01:53.280 --> 00:01:58.280 We will briefly describe each of these economists' respective business cycle theories. 23 00:01:58.280 --> 00:02:04.280 And then we will discuss whether or not their theory they propose identifies a symptom or a cause. 24 00:02:04.280 --> 00:02:09.280 Sustainable Growth 25 00:02:09.280 --> 00:02:14.280 Hayek once said, before we can understand, before we can even ask how things might go wrong, 26 00:02:14.280 --> 00:02:17.280 we must first explain how they could ever go right. 27 00:02:17.280 --> 00:02:22.280 So in that spirit, let's examine how each economist views the economy going right. 28 00:02:24.280 --> 00:02:28.280 According to Hayek, sustainable growth comes from savings through time. 29 00:02:28.280 --> 00:02:33.280 As described by Professor Garrison in his capital-based macroeconomics slideshow 30 00:02:33.280 --> 00:02:37.280 with that fancy PowerPoint and interlocking graphs and animations, 31 00:02:37.280 --> 00:02:40.280 there can either be savings, investing or consumption. 32 00:02:40.280 --> 00:02:42.280 But the key to this is time. 33 00:02:42.280 --> 00:02:46.280 What is saved today can be used for either investment or consumption tomorrow. 34 00:02:46.280 --> 00:02:57.280 The structure of production lengthens. There is no duex machina aka government intervention or the Fed. Sustainable growth occurs from the market coordinating time and interest. 35 00:02:58.280 --> 00:03:05.280 Now, how does Friedman view sustainable growth without the use of duex machina? You got me there. 36 00:03:06.280 --> 00:03:11.280 How does Minsky view sustainable growth? You got me there as well. 37 00:03:11.280 --> 00:03:41.280 And how about our good friend Keynes? Nada, zilch. Friedman, Minsky, and Keynes do not have an explanation of how things go right, of how the economy produces sustainable growth, but strangely enough, they were able to develop a theory of how things go wrong. But none provide explanations of sustainable economic growth sans a duex machina. So, let's take a look at how things can go wrong. Let's take a look at each of these business cycle theories. 38 00:03:41.280 --> 00:03:48.240 First, the correct business cycle theory from Hayek. The central bank artificially lowers 39 00:03:48.240 --> 00:03:53.000 interest rates, not to mention creates fiat money. With cheap money, easily available, 40 00:03:53.000 --> 00:03:57.680 consumers are less likely to save and more likely to consume. Furthermore, entrepreneurs 41 00:03:57.680 --> 00:04:02.340 attempt to utilize the cheap money by investing. All things being equal, consumers spend on 42 00:04:02.340 --> 00:04:06.100 things they otherwise wouldn't spend, and entrepreneurs invest in projects they otherwise 43 00:04:06.100 --> 00:04:13.860 In essence, there is overconsumption and overinvestment. This spurs the boom. The structure of production 44 00:04:13.860 --> 00:04:17.940 can't decide whether it needs to lengthen or shorten. There is a growing imbalance between 45 00:04:17.940 --> 00:04:23.260 savings, consumption and investment. Eventually, the malinvestment and overconsumption of capital 46 00:04:23.260 --> 00:04:29.060 becomes readily apparent and the economy busts. According to Hayek, the boom is a crisis and 47 00:04:29.060 --> 00:04:34.020 the bust resolves a crisis. The market itself is best suited to coordinate time and interest, 48 00:04:34.020 --> 00:04:36.020 Savings, Investment and Consumption. 49 00:04:36.020 --> 00:04:38.820 The ultimate cure would be to eliminate central banking 50 00:04:38.820 --> 00:04:41.580 and allow for competing private currencies. 51 00:04:44.380 --> 00:04:46.780 Let's take a look at Friedman. 52 00:04:46.780 --> 00:04:49.020 In regards to cause, the literature is unclear 53 00:04:49.020 --> 00:04:51.740 as to what Friedman thinks is the actual cause. 54 00:04:51.740 --> 00:04:55.620 In some sources, he references a large supply shock. 55 00:04:55.620 --> 00:04:57.620 In other references, he points to central bank 56 00:04:57.620 --> 00:05:00.540 not keeping up with the fluctuating money supply. 57 00:05:00.540 --> 00:05:03.980 Friedman thinks the business cycle is a monetary phenomena. 58 00:05:03.980 --> 00:05:09.460 Furthermore, the cure to the business cycle, according to Friedman, is with monetary policy. 59 00:05:09.460 --> 00:05:14.640 The central bank must fluctuate money supply accordingly. Hence, Friedman and his ilk are 60 00:05:14.640 --> 00:05:19.980 nicknamed the monetarists. 61 00:05:19.980 --> 00:05:25.020 Minsky on the other hand provides an interesting theory. Minsky's theory is called the financial 62 00:05:25.020 --> 00:05:29.920 instability hypothesis. When I first was reading about his proposed cause, I thought I was 63 00:05:29.920 --> 00:05:39.920 Minsky suggested that fluctuations in credit and interest rates entice borrowers. He divided borrowers into three types, hedge borrowers, speculated borrowers and ponzi borrowers. 64 00:05:39.920 --> 00:05:51.920 Easy credit allows more borrowing. These borrowers contributed to the accumulation of insolvent debt. Banks then tighten credit and the economy contracts. This is called the Minsky moment. 65 00:05:51.920 --> 00:06:04.920 However, Minsky's cure gave it away that he was no Austrian. He posited that a free-market economy inevitably produces the boom-bust cycle unless government and the central bank step in to regulate. 66 00:06:04.920 --> 00:06:19.920 Keynes suggested that economic instability stems from several causes, the fluctuations in aggregate demand, speculation, and just the very nature of man, or what Keynes refers to as animal spirits. 67 00:06:19.920 --> 00:06:25.920 and Animal Spirits. Keynes uses the term animal spirits to define a spontaneous urge to action. 68 00:06:25.920 --> 00:06:32.920 Keynes' cure for the bust was to boost aggregate demand via a strong fiscal policy. 69 00:06:32.920 --> 00:06:37.920 The government needs to prime the pump through deficit spending in order to get the economy back on its feet. 70 00:06:37.920 --> 00:06:46.920 It is the combination cures of both Friedman and Keynes' monetary policy that runs rampant in mainstream economics today. 71 00:06:46.920 --> 00:06:56.920 Now, the question remains, are the alleged causes of Friedman, Minsky and Keynes actually just symptoms? 72 00:06:56.920 --> 00:07:02.920 But before we get to that, let's get rid of some of the alleged cures. 73 00:07:02.920 --> 00:07:11.920 A strong monetary policy, government intervention and strong fiscal policy, advocated by Friedman, Minsky and Keynes respectively, will not work to cure the bust. 74 00:07:11.920 --> 00:07:19.920 Ironically, it is the strong monetary policy, government intervention and fiscal policy itself that leads to the boom and thus the bust. 75 00:07:19.920 --> 00:07:26.920 We can't cure the economy with the problem that started it. The economy needs to be given the chance to heal itself. 76 00:07:26.920 --> 00:07:34.920 Now to the symptoms. Friedman suggested business cycles are due to supply shocks and money supply. 77 00:07:34.920 --> 00:07:41.920 This is actually a symptom. Supply shocks can be seen as what Hayek refers to as the lengthening or shortening of the structure of production. 78 00:07:41.920 --> 00:07:51.920 In terms of money supply, Friedman suggested that cause was not enough money going around, but he did not take into account time. 79 00:07:51.920 --> 00:07:58.920 Consumers and investors alike need to save. Both these causes are actually just symptoms. 80 00:07:58.920 --> 00:08:03.920 Minsky suggested business cycles are due to easy credit and eager borrowers. 81 00:08:03.920 --> 00:08:08.920 This falls under what Austrians call malinvestment and overconsumption. 82 00:08:08.920 --> 00:08:13.920 Easy money is being spent or invested where it otherwise would not. 83 00:08:13.920 --> 00:08:17.920 The cause is not the eager borrower nor the easy credit. 84 00:08:17.920 --> 00:08:22.920 The question is, what caused the easy credit in the first place? 85 00:08:22.920 --> 00:08:24.920 In other words, the cause is the central bank. 86 00:08:24.920 --> 00:08:30.920 Easy credit and, hence, eager borrowers are merely symptoms of the central bank policy. 87 00:08:30.920 --> 00:08:37.920 Likewise, Keynes suggested that animal spirits and loss of aggregate demand is the cause of the boom bust. 88 00:08:37.920 --> 00:08:44.920 It is obvious that fluctuations in aggregate demand is a symptom because something had to cause aggregate demand to drop. 89 00:08:44.920 --> 00:08:48.920 It's kind of like saying it's raining because water is falling from the sky. 90 00:08:48.920 --> 00:08:53.920 Why is water falling from the sky? Why is aggregate demand fluctuating? 91 00:08:53.920 --> 00:08:58.920 It's not the bust we look at, but the unsustainable boom to find the answer to this question. 92 00:08:58.920 --> 00:09:04.920 As for animal spirits, individuals will act in their own self-interest according to the information individuals have. 93 00:09:04.920 --> 00:09:09.920 If the information is distorted, the individual's actions will be distorted. 94 00:09:09.920 --> 00:09:14.920 The economy was distorted by the cause, artificial inflation of the money supply via the central bank. 95 00:09:14.920 --> 00:09:18.920 Hence, animal spirits is just a symptom as well. 96 00:09:18.920 --> 00:09:32.440 Thus, Keynes, Friedman and Minsky were in one respect right, but in a fundamental respect 97 00:09:32.440 --> 00:09:33.440 completely wrong. 98 00:09:33.440 --> 00:09:38.680 Each of the three economists had insight into the various symptoms of the Boehm-Bawerk cycles, 99 00:09:38.680 --> 00:09:42.920 but did not take their arguments far enough to understand the root cause. 100 00:09:42.920 --> 00:09:47.640 Their solutions only viewed the symptoms of business cycles, malinvestment and misallocation 101 00:09:47.640 --> 00:09:53.920 of Resources. Furthermore, their solutions instigate the next recession. Unfortunately, 102 00:09:53.920 --> 00:10:00.120 their theories do not understand the root cause of boom-bust cycles. 103 00:10:00.120 --> 00:10:05.320 Mises and Hayek's contributions have the explanation which takes into account the symptoms of Keynes 104 00:10:05.320 --> 00:10:10.880 Friedman-Minsky and more so the root cause. The Mises-Hayek Business Cycle Theory has 105 00:10:10.880 --> 00:10:16.480 the full understanding of the root cause of boom-bust, fiat money and the central control 106 00:10:16.480 --> 00:10:21.480 and the symptoms of malinvestment and misallocation of resources. 107 00:10:21.480 --> 00:10:26.480 Furthermore, the series suggests that the solution to thwarting business cycles 108 00:10:26.480 --> 00:10:30.480 is abolishing centralized control of money and the money supply. 109 00:10:30.480 --> 00:10:37.480 All in all, the Austrians have the theory that understands the cause, the symptoms, and the cure to business cycles.