WEBVTT NOTE Hayek’s Relevance for 21st-Century Boom-Bust and Recession-Recovery 1 00:00:00.000 --> 00:00:08.000 It was about 30 years ago that Fred Glahey at the University of Colorado handed me about a page and a half of notes 2 00:00:08.000 --> 00:00:17.000 that he'd give as commentary on the Hayek-Keynes debate at the Mount Pilaran Society and told me turn this into a dissertation. 3 00:00:17.000 --> 00:00:26.000 At that time, I had read Little Hayek, even less of Mises, and even less of Rothbard. 4 00:00:26.000 --> 00:00:43.000 So it was turned into a five-year process of essentially redoing a graduate program on my own out in Boulder, Colorado before all these amazing resources are available on the web that give you access to this stuff. 5 00:00:43.000 --> 00:00:47.000 So it's really good to be back in terms of this. 6 00:00:47.000 --> 00:01:03.440 And I'd also just like to take a moment and dedicate this presentation to a dearly missed colleague, Larry Seacrest, who I would love to have him still around here to be listening to his insights in this. 7 00:01:03.440 --> 00:01:11.680 So I'm also a PowerPoint virgin. 8 00:01:11.680 --> 00:01:16.760 So this is the first time I have been told this. 9 00:01:16.760 --> 00:01:19.760 And I think I've got some creative slides. 10 00:01:19.760 --> 00:01:22.720 But if you were here earlier, I have none 11 00:01:22.720 --> 00:01:27.920 that were as creative as Bob Milligan's second slide. 12 00:01:27.920 --> 00:01:30.880 If you remember the screen, it was really 13 00:01:30.880 --> 00:01:35.600 a slide of all the propositions from Keynesian theory 14 00:01:35.600 --> 00:01:37.600 that were both true and relevant. 15 00:01:37.600 --> 00:01:58.600 let's see now I guess I need to be able to move forward okay first slide came to 16 00:01:58.600 --> 00:02:04.200 me from my twin brother about the time of the last recession so you can see 17 00:02:04.200 --> 00:02:09.480 There are some people that may have a different view of Hayek's relevance. 18 00:02:10.160 --> 00:02:15.280 If you can't read that, it shows the two characters. 19 00:02:15.280 --> 00:02:19.520 And one of them says, Frederick Hayek and John Keynes argued incessantly, 20 00:02:19.800 --> 00:02:22.560 their ideas shaped modern economic thought. 21 00:02:23.360 --> 00:02:28.040 Even today, the struggle between the Keynesians and Austrians rages on. 22 00:02:28.440 --> 00:02:29.840 And the other one says, that's good. 23 00:02:29.840 --> 00:02:32.640 I can whistle the Seinfeld theme through my nose. 24 00:02:34.200 --> 00:02:43.560 So, OK, for some of us that have been writing on the Austrian business cycle theory through 25 00:02:43.560 --> 00:02:50.880 the last 15 to 20 years, I think particularly by the second one we felt very much this is 26 00:02:50.880 --> 00:02:56.280 a quote from Hayek in the mid 70s. 27 00:02:56.280 --> 00:03:01.400 The publication was a Cato publication in 79, but I think it reprints some lectures 28 00:03:01.400 --> 00:03:10.200 in the mid-70s, and a couple things in here, he says, I've been preaching for 40 years 29 00:03:10.200 --> 00:03:18.880 that this over-expansion of the money supply misdirects production, creates temporary unemployment 30 00:03:18.880 --> 00:03:22.360 that will often lead to even greater unemployment in the future. 31 00:03:22.360 --> 00:03:29.060 And now we're in that, Major and I think too often overlooked in this discussion, catastrophe 32 00:03:29.060 --> 00:03:34.980 of the 1970s and early 1980s, where we really had double-digit unemployment, double-digit 33 00:03:34.980 --> 00:03:41.500 inflation, and while the slowdown didn't last near as long as this one, it was certainly 34 00:03:41.500 --> 00:03:45.300 much deeper and we should take that into account. 35 00:03:45.300 --> 00:03:49.020 And he's kind of, now you ask me, what do we do when we're in the cycle, and you still 36 00:03:49.020 --> 00:03:55.140 hear some of that right now about the Austrians in here, your policy's too harsh, I've addressed 37 00:03:55.140 --> 00:04:17.140 I'm going to focus more on the boom and the bust relevance here at an earlier paper in QJE last fall where I try to go the other way and what's the relevance for these Austrian policy for the recession and the recovery and I think there's a lot more there that's been under-appreciated and under-pushed in there. 38 00:04:17.140 --> 00:04:47.140 Another thing I kind of want to go back to is that is overlooked particularly by the people pushing just general stimulus on the economy. Going back, and this is a quote from Hayek's monetary theory in the trade cycle, which was really his earlier work in German in 1929 was translated into English in 1933. But he's talking about what's the task as we try to 39 00:04:47.140 --> 00:04:55.180 separate out good business cycles from bad business cycle theory and I've got some citations 40 00:04:55.180 --> 00:05:00.620 in there that I think it's even clear that Keynes accepted this fundamental that the 41 00:05:00.620 --> 00:05:06.980 task is made easier on at least one point. Then when we look at fluctuations, we not 42 00:05:06.980 --> 00:05:15.860 only have the up and down in GDP, but what we tend to see is the relatively greater instability 43 00:05:15.860 --> 00:05:23.180 in the component that we would call business or future-oriented spending relative to consumption. 44 00:05:23.180 --> 00:05:27.980 The second point that I think we need to be much, much clearer on is that, as we're talking 45 00:05:27.980 --> 00:05:35.560 about these things, is the relevant discussion in this point is not the absolute fluctuations 46 00:05:35.560 --> 00:05:39.100 up and down, but the relative magnitudes. 47 00:05:39.100 --> 00:05:48.260 And in a boom, the investment components are expanding not only in absolute terms, but 48 00:05:48.260 --> 00:05:52.260 relative to their overall size in the economy. 49 00:05:52.260 --> 00:05:53.460 So investment is increasing. 50 00:05:53.460 --> 00:05:56.860 I've got some other comments in the paper, and there's a few copies up here if anybody 51 00:05:56.860 --> 00:06:02.020 is interested, that we also kind of face the problem on the relative magnitude of investment 52 00:06:02.020 --> 00:06:07.840 to consumption is that the way we measure in the product of income accounts greatly 53 00:06:07.840 --> 00:06:13.940 understates the amount of current economic activity that's really being undertaken right 54 00:06:13.940 --> 00:06:22.220 now, not to produce goods now, but to produce them in a future stream, so we'll stylize 55 00:06:22.220 --> 00:06:23.540 facts. 56 00:06:23.540 --> 00:06:27.900 As far as the relevance to the cycle, and these are just some simple things in here, 57 00:06:27.900 --> 00:06:31.980 is that we should see two things going on. 58 00:06:31.980 --> 00:06:38.940 One is the first cycle, and I think that we really need to be looking at these two periods 59 00:06:38.940 --> 00:06:48.420 as really a single phenomena, that we probably did have a productivity-driven expansion, 60 00:06:48.420 --> 00:06:53.480 and that shows up in the period in the early 90s where you actually see the blue line is 61 00:06:53.480 --> 00:07:00.180 real gross domestic product is being produced at a level higher than what people were estimating 62 00:07:00.180 --> 00:07:04.980 is the trend potential or full employment GDP. 63 00:07:04.980 --> 00:07:11.660 That was the first phase of the cycle, which to me was an Austrian cycle that was piggybacked 64 00:07:11.660 --> 00:07:14.340 on a productivity cycle. 65 00:07:14.340 --> 00:07:21.240 That the increased investment demand was driving the demand for credit and a Federal Reserve 66 00:07:21.240 --> 00:07:28.180 banking system that was targeting interest rates just accommodated the expansion of credit 67 00:07:28.180 --> 00:07:34.180 that led to this over-expansion in the, at this time, we saw a lot of it in the dot-com 68 00:07:34.180 --> 00:07:37.580 boom, that type of segment in there. 69 00:07:37.580 --> 00:07:45.980 We got a correction, temporary recession that also, like this one, the press beat up as 70 00:07:45.980 --> 00:07:49.120 a jobless recovery for a long period of time. 71 00:07:49.120 --> 00:07:55.160 And what we saw in this one is an attempt, the active part of the policy of the Federal 72 00:07:55.160 --> 00:08:25.160 The Federal Reserve or even John Taylor has some pretty good work on this that the Fed kept interest rates far too low for far too long and if they were too low for a Taylor rule you can imagine how low they were relative to a natural rate in here and this one's kind of interesting because it created what looks like a quasi-recovery we got a very shallow recession and GDP recovers back to the trend 73 00:08:55.160 --> 00:09:03.200 The facts, I think, still show up, and if you want another look at this in broader terms is there's a... 74 00:09:03.200 --> 00:09:11.200 I think David Romer has an advanced micro text, has a pretty good chapter on the real business cycle theory, 75 00:09:11.200 --> 00:09:18.200 and look at those stylized facts, and they clearly show greater fluctuations in time-related activities, 76 00:09:18.200 --> 00:09:20.200 including durable consumer goods. 77 00:09:20.200 --> 00:09:44.200 This is a chart that, the first one, the blue line is just gross domestic investment, measured in real dollars, absolute terms, and again you can see the trend in here, during the boom phase in here, investment is increasing very significantly, steep rates, collapses during the recession, you get the following trend in here. 78 00:09:44.200 --> 00:10:14.200 The red line is average weekly employment in the private sector, so the other thing I just wanted to show is that not only do we get this trend in here, but when you actually look at employment of labor resources during this period, the trend very, very closely follows the trend in investment, and then to reinforce kind of the impact, this one is essentially showing gross private domestic investment, 79 00:10:14.200 --> 00:10:21.280 Relative to Total GDP and again you'll see during the boom phases very very 80 00:10:21.280 --> 00:10:27.680 high levels relative to average of the percent of economic activity even in the 81 00:10:27.680 --> 00:10:33.280 GDP product and income accounts that's being picked up in there. Mark Skousen 82 00:10:33.280 --> 00:10:37.360 has been working on a measure he calls gross domestic investment that when he 83 00:10:37.360 --> 00:10:43.840 bad news is is the data he uses as much of its based on tax data and it's most 84 00:10:43.840 --> 00:11:08.140 The most recent is about two years old, but his kind of preliminary reports is that even in that measure of expenditures, consumption drops from the 60, it's almost 70% in the GDP account down to about 30% and investment spending measured in that becomes almost 70% or about double consumption rather than what looks like a small component of that. 85 00:11:08.140 --> 00:11:17.140 This was for later. This is just kind of five minutes. Boy, we'll speed through this then. 86 00:11:17.140 --> 00:11:22.140 That shows a decline in nominal GDP. We'll ignore that. I'll skip through. 87 00:11:22.140 --> 00:11:33.140 First, Hayek's cycle theory, and just real quick, I want to emphasize that the way he designed the cycle theory and to some extent Mises is there's two key components. 88 00:11:33.140 --> 00:12:03.140 Components. The first that I'll call the theoretical components that long run, essentially, and I think I prefer to put that essentially tastes and preferences and resource scarcity is what determines relative prices, not monetary phenomena. The second, I think, is very, very important, the Kantian effects that Mark Thornton's done a lot with, that monetary injections create distortions in flows of spending relative to flows of resource 89 00:12:03.140 --> 00:12:10.980 So distort relative prices and cause temporary flows in resources, in direction, the monetary, 90 00:12:10.980 --> 00:12:16.900 which will have to be reversed when the monetary injections don't accelerate. 91 00:12:16.900 --> 00:12:21.140 And then there's two empirical foundations to the Austrian business cycle theory. 92 00:12:21.140 --> 00:12:26.900 One, looking at the nature of the financial system, was a belief at that time with a fractional 93 00:12:26.900 --> 00:12:32.100 reserve banking system, and I think reinforced if there's a central bank, that normally 94 00:12:32.100 --> 00:12:38.660 The additional money balances enter the spending stream through loans made through the commercial 95 00:12:38.660 --> 00:12:43.620 banking through the fractional reserve banking system in there. 96 00:12:43.620 --> 00:12:51.140 And the second proposition then is that normally those loans go to businesses or entrepreneurs. 97 00:12:51.140 --> 00:12:56.580 That is what leads you with the decline in there to see the relative expansion of investment 98 00:12:56.580 --> 00:12:58.620 following a monetary decline. 99 00:12:58.620 --> 00:13:28.620 Declined. I want to go through this. It's kind of an interesting thing. Two critics of Hayek listed 10 propositions that they saw in his theory. And Hayek kind of says, there's a minor scribble on that. It's a pretty good summary. And I think it still holds up pretty well in broad general terms on his Capital Theory framework. And I added a tenth point to my own 100 00:13:28.620 --> 00:13:38.620 When money is created in an economy that is not fully employed, it may initially be stimulated. 101 00:13:38.620 --> 00:13:44.620 It will show up in employment, but you still get the same distortions in the economy, 102 00:13:44.620 --> 00:13:49.620 so what you are just doing is continually setting up these booms and busts in here. 103 00:13:49.620 --> 00:13:55.620 Hayek in the 1970s, or during this 1930 period, the other thing I will emphasize is that 104 00:13:55.620 --> 00:14:03.620 that he made some very, very strong arguments against price stabilization as a goal in monetary policy. 105 00:14:03.620 --> 00:14:13.620 And that really would fit my first business cycle scenario, where you're kind of piggybacking on a productivity-driven growth. 106 00:14:13.620 --> 00:14:23.620 Prices should actually be falling, so anything targeting stable prices would essentially be distorting the economy 107 00:14:23.620 --> 00:14:36.620 In the 1970s, he's looking at 30 years of data in here, hadn't seen much of this going on, and he kind of backs off of this. 108 00:14:36.620 --> 00:14:44.620 He emphasizes the Kantian effects, he emphasizes that distortions in the economy, 109 00:14:44.620 --> 00:14:51.620 flow of money spending that's different from the flow of resources is a major cause of unemployment in there, 110 00:14:51.620 --> 00:14:56.420 and that leads us really to a recession if you've got a misdirection of 111 00:14:56.420 --> 00:15:00.300 unemployment relative prices are wrong if you want stable long-term full 112 00:15:00.300 --> 00:15:06.580 employment you've got to allow prices and wages to adjust and get the spending 113 00:15:06.580 --> 00:15:15.980 streams in line with the resource streams in there but he does two things 114 00:15:15.980 --> 00:15:20.420 in there he argues that when you look at that monetary system may be targeting 115 00:15:20.420 --> 00:15:26.420 Banking Price Stabilization is not so bad. 116 00:15:26.420 --> 00:15:30.140 Doesn't look like that causes that bad a problem compared to other types of things. 117 00:15:30.140 --> 00:15:36.340 And then on kind of empirical grounds, he kind of abandons the capital theory in there. 118 00:15:36.340 --> 00:15:40.420 He's saying, you look at, we're now making loans to consumers, we're doing all this 119 00:15:40.420 --> 00:15:45.540 type of thing, it's not clear to him that you can as clearly delineate these misdirections 120 00:15:45.540 --> 00:15:46.540 in there. 121 00:15:46.540 --> 00:15:52.860 The conclusion of the paper is I think he was wrong on both of these points, that we 122 00:15:52.860 --> 00:16:00.020 can clearly see, and even Alex Leonhoff had cited in the paper, clearly calls this last 123 00:16:00.020 --> 00:16:08.020 crisis Hayekian, not Keynesian, that it's a misdirection of production. 124 00:16:08.020 --> 00:16:15.020 And the other was kind of a fight with Larry White, who in a 1999 paper maybe argued that 125 00:16:15.020 --> 00:16:19.020 Hayek in the 70s abandoned his business cycle theory. 126 00:16:19.020 --> 00:16:22.020 And I say, no, he made a couple of minor adjustments 127 00:16:22.020 --> 00:16:26.380 in empirical and on those two things he was right. 128 00:16:26.380 --> 00:16:29.620 But the foundation of his business cycle theory, 129 00:16:29.620 --> 00:16:32.940 the two theoretical components, he never did abandon. 130 00:16:32.940 --> 00:16:35.620 And he stayed pretty consistent to that 131 00:16:35.620 --> 00:16:37.060 in some of the other deals. 132 00:16:37.060 --> 00:16:40.140 So I am about to get shot by Bill. 133 00:16:40.140 --> 00:16:42.820 But that's because he took my five minutes being late. 134 00:16:45.020 --> 00:16:47.020 Thank you very much.