WEBVTT NOTE New Paths in Austrian Macroeconomics 1 00:00:00.000 --> 00:00:15.000 This paper that Walter and I are doing, it's a working paper and it draws on some things that we've done in the past and attempts to bring them together. 2 00:00:15.000 --> 00:00:31.000 Some of it is pedagogical, but it seems to me a pedagogical that has substantive implications and other parts of it seem to me substantive that have pedagogical implications for it. 3 00:00:31.000 --> 00:00:44.000 A few years back, three, four years, I don't know, Walter and I published a couple of papers on what has come to be called, or what people call, maturity mismatching. 4 00:00:44.000 --> 00:00:54.160 I don't like that term because maturity mismatching can be of different types and if you talk 5 00:00:54.160 --> 00:01:01.760 to mainstreamers and all, if you look at the duration, the calculation of the duration, 6 00:01:01.760 --> 00:01:08.120 you can have a situation where you have maturity mismatching, well it's okay because the asset 7 00:01:08.120 --> 00:01:12.120 that duration is the same as the liability duration on our balance sheet, so that's 8 00:01:12.120 --> 00:01:18.200 a big, you know, that's okay. But I'm always reminded of the story about the six-foot tall 9 00:01:18.200 --> 00:01:27.200 man who drowned while trying to walk across the river whose average depth was one foot. 10 00:01:27.200 --> 00:01:36.980 So, you know, we have that. Another thing that came up in this was the idea that borrowing 11 00:01:36.980 --> 00:01:44.220 Borrowing $10 for one year is very, very different than borrowing $10 for 10 years. We tend to 12 00:01:44.220 --> 00:01:53.220 measure credit in terms of the amount of money borrowed, but actually if you think in terms 13 00:01:53.220 --> 00:01:59.240 of dimensions, credit has a time dimension as well. $10 borrowed for one year is very 14 00:01:59.240 --> 00:02:04.780 different than $10 borrowed for two years. And $10 borrowed for one year is very different 15 00:02:04.780 --> 00:02:12.300 than $1 barred for 10 years, and this problem comes up in the finance, I know Joe teaches 16 00:02:12.300 --> 00:02:18.240 finance, you know, does some of that stuff with the MBAs, how do you compare two investment 17 00:02:18.240 --> 00:02:23.780 projects that have the same net present value, but one has a maturity of one year and the 18 00:02:23.780 --> 00:02:31.700 other has a maturity of 10 years? So, anyway, that gets us to the idea, and I'll be getting 19 00:02:31.700 --> 00:02:40.540 The idea of maturity mismatching in the form of borrowing short, lending long, Walter and 20 00:02:40.540 --> 00:02:44.900 I wrote a paper about that, as I said was published a few years ago, and if you think 21 00:02:44.900 --> 00:02:53.900 about what's going on there, what's happening is that as long as that's legal, the private 22 00:02:53.900 --> 00:02:59.380 sector is doing what the Fed is trying to do right now and has tried to do early. 23 00:02:59.380 --> 00:03:07.340 The Fed in the early 60s tried Operation Twist, right, to drive down long-term rates and drive 24 00:03:07.340 --> 00:03:08.580 up short-term rates. 25 00:03:08.580 --> 00:03:13.320 They were doing it at that time for balance of payments and reasons, but also because 26 00:03:13.320 --> 00:03:15.760 of the slow domestic economy. 27 00:03:15.760 --> 00:03:23.100 But if you think about, if we have private institutions that are borrowing short, attending 28 00:03:23.100 --> 00:03:27.320 to drive up short-term rates, but they take the money and lend it long, that turns to 29 00:03:27.320 --> 00:03:35.080 to lower long term rates, obviously that has implications for business cycles from an Austrian perspective. 30 00:03:35.080 --> 00:03:41.400 On the other hand, and again, you don't see that much of this, but if you borrow long 31 00:03:41.400 --> 00:03:47.660 and lend short, then to my way of thinking, that has implications for growth, it slows 32 00:03:47.660 --> 00:03:53.920 down growth because in that case, resources get diverted from long term projects to shorter 33 00:03:53.920 --> 00:03:57.160 term projects and consumption. 34 00:03:57.160 --> 00:04:05.440 That brings us to the idea that really it's credit expansion, not monetary expansion, 35 00:04:05.440 --> 00:04:07.000 that is critical. 36 00:04:07.000 --> 00:04:12.820 Monetary expansion, nobody's, if you think about it, Mises talked about the circulating 37 00:04:12.820 --> 00:04:17.720 credit theorem, a theory of the business cycle. 38 00:04:17.720 --> 00:04:26.180 He was not concerned with fiat money being lent into, excuse me, being spent into existence. 39 00:04:26.180 --> 00:04:30.220 If the federal government right now is running these deficits, and just saying, okay, we're 40 00:04:30.220 --> 00:04:34.060 running a trillion dollar deficit, let's just print a trillion dollars and spend it, well 41 00:04:34.060 --> 00:04:38.900 obviously we would have huge inflation problems, and everybody understands that. 42 00:04:38.900 --> 00:04:45.140 But it wouldn't cause a business cycle, certainly not of the Austrian style. 43 00:04:45.140 --> 00:04:51.820 But it's when you lend new money into existence that it enters the economy through the financial 44 00:04:51.820 --> 00:04:56.740 Market and distorts interest rates and that causes the distortion of the structure of 45 00:04:56.740 --> 00:05:05.220 prices which then leads to the unsustainable distortion of the structure of production. 46 00:05:05.220 --> 00:05:10.140 Now all of that leads us to think that, you know, if you start thinking about this then 47 00:05:10.140 --> 00:05:19.860 you say, well, there's actually all kind of ways you can characterize financial institutions 48 00:05:19.860 --> 00:05:29.460 But one way is to characterize them as brokers or dealers, where a broker merely brings together 49 00:05:29.460 --> 00:05:35.980 the borrower and the lender and charges a fee or commission for the process, whereas 50 00:05:35.980 --> 00:05:40.300 a dealer is a principal, not an agent. 51 00:05:40.300 --> 00:05:47.860 A dealer goes in and borrows money from somebody and then relends it. 52 00:05:47.860 --> 00:05:56.300 So if you think about a bank as a bank's a dealer, at least most people I know don't 53 00:05:56.300 --> 00:06:03.300 usually think about that, but the bank sells deposits and then the bank takes the funds 54 00:06:03.300 --> 00:06:07.820 it got from those deposits and buys notes. 55 00:06:07.820 --> 00:06:15.500 So really to get a real handle on that, unlike these diagrams, the first one is the typical 56 00:06:15.500 --> 00:06:25.260 The second one shows the typical comparison from the Austrian point of view of what happens 57 00:06:25.260 --> 00:06:33.100 if there's an increase in the supply of loanable funds because people save more versus an increase 58 00:06:33.100 --> 00:06:39.780 in the supply of loanable funds because of an increase in the money supply. 59 00:06:39.780 --> 00:06:47.620 But actually, if you're going to show this kind of situation in the banking system, you 60 00:06:47.620 --> 00:06:50.580 really need two figures for each of those. 61 00:06:50.580 --> 00:06:56.060 Let me see if I can get to the next one. 62 00:06:56.060 --> 00:07:02.460 One thing this leads us to do is to think that perhaps it would be more useful pedagogically 63 00:07:02.460 --> 00:07:09.460 to get away from loanable funds models where the price of the loanable funds is the interest 64 00:07:09.460 --> 00:07:15.900 Interest Rate, and you have a demand for loanable funds and a supply of loanable funds, 65 00:07:15.900 --> 00:07:23.020 but loanable funds are money, and the price is an interest rate? Far better to put it 66 00:07:23.020 --> 00:07:30.540 in terms of financial assets, where you have a demand and supply for financial assets, 67 00:07:30.540 --> 00:07:38.700 not in terms of an interest rate, but in terms of a price, right? And of course, the price 68 00:07:38.700 --> 00:07:45.540 This then is a real money price. It's so many dollars for a bond or whatever it is. So that's 69 00:07:45.540 --> 00:07:54.460 one of the things where we think there's something to do both where the pedagogy and the substance 70 00:07:54.460 --> 00:08:03.660 are linked there and we need to do that. 71 00:08:03.660 --> 00:08:09.700 The next thing that we thought about was that the standard model that we use when we're 72 00:08:09.700 --> 00:08:16.380 talking about growth in the Austrian model is, we say, well, growth comes about because 73 00:08:16.380 --> 00:08:22.920 of a decline in time preference, which leads to an increase in saving, which reduces the 74 00:08:22.920 --> 00:08:29.740 interest rate, and we get an increase in investment, but it's not an increase in investment, it's 75 00:08:29.740 --> 00:08:34.580 using the typical language or the standard language, it's an increase in the quantity 76 00:08:34.580 --> 00:08:40.600 demanded of investment. We slide down the investment curve. The supply of savings shifts 77 00:08:40.600 --> 00:08:47.900 out and we slide down the investment curve. In point of fact, I do believe that history 78 00:08:47.900 --> 00:08:52.780 would show and reality shows, and obviously Schumpeter agreed with this and all that, 79 00:08:52.780 --> 00:08:58.620 but the dynamic force for growth in the economy is not the household and not the consumer 80 00:08:58.620 --> 00:09:05.060 who is increasing savings, perhaps because wealth is going up or whatever, but the dynamic 81 00:09:05.060 --> 00:09:10.560 force in the economy is the entrepreneur, and the entrepreneur sees opportunities for 82 00:09:10.560 --> 00:09:21.740 profits and shifts out the demand for loanable funds, okay, and when they shift out the demand 83 00:09:21.740 --> 00:09:29.140 for Loanable Funds, then the quantity supplied of saving obviously rises to meet it. 84 00:09:29.140 --> 00:09:36.560 So in either case, with either one of those models you use, whether it's the increase 85 00:09:36.560 --> 00:09:43.480 in saving or the increase in investment, they're both going to end up, the actual quantities 86 00:09:43.480 --> 00:09:45.920 have to be the same. 87 00:09:45.920 --> 00:09:50.420 Saving and investment in the real world are the same thing, okay, so they have to be the 88 00:09:50.420 --> 00:09:57.420 the same thing, but the model, thank you, Joe, the model where the demand for investment 89 00:09:57.420 --> 00:10:03.220 or the investment demand curve shifts out, if you look at the new equilibrium at the 90 00:10:03.220 --> 00:10:08.180 higher quantity of saving and investment, interest rates have gone up. 91 00:10:08.180 --> 00:10:13.660 And we all know that everybody in the financial world, everybody in business understands that 92 00:10:13.660 --> 00:10:18.220 as soon as they think there's going to be growth is coming, interest rates go up. 93 00:10:18.220 --> 00:10:19.220 Why? 94 00:10:19.220 --> 00:10:23.120 Because the demand for investment funds are going up. 95 00:10:23.120 --> 00:10:30.980 So we think that that's both pedagogy to show what's going on by saying, look, it's not 96 00:10:30.980 --> 00:10:36.160 the increase in the supply of loanable funds because of savings increasing, because of 97 00:10:36.160 --> 00:10:42.620 a decrease in time preference, but it's an increase in investment demand because entrepreneurs 98 00:10:42.620 --> 00:10:46.140 see an increase in profit opportunity. 99 00:10:46.140 --> 00:10:47.780 So we think that's that. 100 00:10:47.780 --> 00:10:57.660 And that just shows the same idea in terms of financial assets, I guess. This is a slightly 101 00:10:57.660 --> 00:11:03.940 different one, and we do it first in figures 6a and 6b in terms of loanable funds, and 102 00:11:03.940 --> 00:11:09.300 then in terms of 7, we do it in terms of financial assets, but I'll do it in terms of the one 103 00:11:09.300 --> 00:11:25.300 I don't understand it because I think most people are probably aware of that, and that is that what happens, we always talk, and this is why I think it's important to focus on credit, not money, loanable funds or not. 104 00:11:25.300 --> 00:11:37.300 If the supply of loanable funds, the supply of savings increases, we say well the interest rate goes down, and you know, if this is due to an increase in money, okay, 105 00:11:37.300 --> 00:11:56.300 There's another possibility, and we see this in the real world, and that is that financial institutions don't necessarily lower interest rates. 106 00:11:56.300 --> 00:12:04.300 Financial institutions are interested, among other things, in maintaining their net interest margin. 107 00:12:04.300 --> 00:12:20.300 So it is not uncommon, and we saw this in the middle of the last decade in the housing market, that rather, I mean, yes, interest rates went down some, but then what did they do? 108 00:12:20.300 --> 00:12:30.300 Remember, the demand curve for loanable funds, if we look at it in that term, is not determined strictly by the borrowers. 109 00:12:30.300 --> 00:12:37.140 I, as the lender, can cause the demand curve for loanable funds to shift out. Why? 110 00:12:37.140 --> 00:12:43.100 Severus Paribus. Demand curves show things, Severus Paribus. That demand curve for loanable 111 00:12:43.100 --> 00:12:49.620 funds is an assumption that the risk profile of the borrowers is the same all along that 112 00:12:49.620 --> 00:12:56.540 demand curve. Well, what happens if I, as the banker, decide I've got more funds to 113 00:12:56.540 --> 00:13:12.540 I don't want to lend out. I don't want to lower the interest rate. I'll cut my net interest margin too much. You know what? Rather than cut my interest rate, I'm going to allow lousier borrowers, people with lower credit risk to borrow. 114 00:13:12.540 --> 00:13:23.540 Well, that shifts out the demand for loanable funds. I think that's important substantively that we recognize that and look at the implications of that. 115 00:13:23.540 --> 00:13:28.540 I think it's also something that we need to take a look at in our pedagogy. 116 00:13:32.540 --> 00:13:35.540 I have some other things I could say, but you know, I think, 117 00:13:37.540 --> 00:13:42.540 they're not directly relevant to, oh, well, I'll just, as long as I have a minute, can I make two points? 118 00:13:42.540 --> 00:13:51.540 One of them is that we talk about the purpose of, you know, investments in saving and investment and all, 119 00:13:51.540 --> 00:13:58.260 and all is that lowering the interest rate is to lengthen the structure of production. 120 00:13:58.260 --> 00:14:03.460 If we understand that, that there's initial structure of production and there's a transition 121 00:14:03.460 --> 00:14:09.380 phase and then there's an end stage, although that may be the case sometimes that we want 122 00:14:09.380 --> 00:14:13.980 to lengthen the structure of production, the permanent one, in point of fact what we do 123 00:14:13.980 --> 00:14:19.700 is we lengthen the structure of production temporarily, but the ultimate ideal end state 124 00:14:19.700 --> 00:14:24.180 structure of production in terms of the Hayekian Triangle is a vertical line 125 00:14:24.180 --> 00:14:28.940 where Barnett says I wish I had a Rolls Royce and boom there it is it's produced 126 00:14:28.940 --> 00:14:35.060 right there the time period of production is reduced that we want the 127 00:14:35.060 --> 00:14:39.980 time period we want that the value of consumption to go up but we want that 128 00:14:39.980 --> 00:14:46.020 triangle to get steeper and flatter we have to go with that and my time is up 129 00:14:46.020 --> 00:14:53.020 Thank you very much.