I had a short argument with Greg Ransom a couple of months back. Greg won. But actually, I wasn't really arguing with him. I was on his side to begin with, though it did help me clarify my views.
Question. "What is the economic difference between capital and land?"
If you answered: "People made capital and God made land", you are wrong.
Economists have known that answer is wrong since 1871, when we discovered that bygones are forever bygones, and switched to the forward-looking marginalist theory of value. In 1871 we stopped saying that the value of goods is determined by what they cost to produce in the past. Instead we said the value of goods is determined by their marginal utility in the present and expected future. (OK, there are two blades of the Marshallian scissors, demand and supply, but both blades are made of the same stuff (Mark Blaug?), because marginal costs are really opportunity costs, and are the foregone marginal utility of the other goods we could make with the same resources.)
It doesn't matter whether people or God made stuff in the past, and what it cost to produce it. The only things that matter are: the present; and present expectations about the future. If archaeologists discovered that Prince Edward Island was an artificial island, rather than a geological formation, it shouldn't matter at all for the allocation of resources going forward. (OK, some geologists would have extra work to do, to revise their theories.)
What is the economic difference between the existing stock of capital goods and the existing stock of land? Nothing really. Except we will, probably, be producing more capital goods in the future, and we won't, probably, be producing more land in the future.
But even that is not quite right. And not just because the Dutch invest in producing more land. The capital goods we are making today aren't always exactly the same as the capital goods we made in the past. Technology changes. I doubt that anyone today is building a computer exactly like the one I'm using now.
Antique furniture is really land, economically speaking. So is my Mazda MX6. They don't make them like that any more. If we lost the blueprints, and couldn't reproduce any of the existing capital goods in future, they would all become land.
The best we can say is that we can and will be producing capital goods that are a much closer substitute for some existing goods than others.
If there's a very elastic supply curve of newly-produced goods that have a high cross-elasticity of demand for some existing goods then we can think of those existing goods as capital. If there's a very inelastic supply curve of newly-produced goods that have only a low cross-elasticity of demand for some existing goods then we can think of those existing goods as land.
Where am I going with all this? Here's where I'm going:
Some people today say that the current/recent recession was caused by past overinvestment. Or malinvestment, for the more sophisticated version. Especially in houses.
And I'm saying there's something logically peculiar about any sort of theory like that, if you approach economics from a praxeological, forward-looking basis. Bygones are supposed to be bygones. It didn't ought to matter how we got to where we are today. All that ought to matter is where we are today, and where we expect to be tomorrow.
Suppose that geologists discovered that we all had false memories of the last decade. The houses that appeared in the US are in fact a very recent geological feature. They just sprung up out of the ground. There wasn't any overinvestment in houses at all. God did it. God overinvested in land. Did God make us poorer by doing that? Would the recession suddenly disappear, when people learned the news?
There is something logically peculiar about the Austrian theory of recessions, as being caused by past overinvestment. Sure, the natural rate of interest would be lower, and the future pattern of investment would be different, if a lot of houses suddenly sprang up out of the ground. But isn't the market supposed to be able to handle things like that?
It's not just the Austrians. It's the Keynesians too, at least those who say we are stuck in a liquidity trap and can't get out.
Suppose we all wake up tomorrow and learn that all the economic statistics published over the last few years are totally wrong. And that our personal memories are false too. We have all been brainwashed by the Martians into believing inflation has been low and real growth low. In fact, Nominal GDP has been humming along quite nicely. Is there any reason to expect that it couldn't continue to hum along quite nicely in future?
True, a few workers seem to have forgotten who their employers are. And a few employers seem to have forgotten who their workers are. But given a few months they could search and find each other again. Or, at least, find new partners.
And the US Fed would be surprised to find its balance sheet is far too large, and it would need to do a very big open market operation to sell a lot of the assets it holds. And commercial banks would be surprised to find their reserves at the Fed were far too large, and the rest of their balance sheets too small.
And a lot of people and banks would discover they seem to have made some past loans at ridiculously low nominal interest rates, so they immediately raise interest rates on new loans.
And firms find their capital stocks seem to be far too small, so they do a lot of investing to get them back up to normal. And households find they are crammed into houses that are smaller than they need be, because there are a lot of houses sitting empty, but they soon sort that one out. And are driving old cars, and wearing old underwear, and so start investing in a lot of new stuff.
But otherwise, the economy could hum along quite happily on the new equilibrium NGDP path.
Suppose we all wake up tomorrow morning and learn that our memories of driving on the right are false. Everybody drives on the left in Canada. We are puzzled to find our steering wheels on the wrong side, and the road signs in the wrong places, but everyone switches to the new equilibrium and drives on the left.
If a change in our memories can switch us to a new equilibrium, why can't an announcement of the new equilbrium, an NGDP target, do the same?
When did economists forget that bygones are supposed to be bygones? (Not that they are, of course, totally).
Worthwhile Canadian Initiative 
Jon: Aha!
So let me give a modified version. Start in equilibrium. then the central bank cuts the interest rate. Investment increases, money supply expands, inflation increases. This is unsustainable, because it’s all going to accelerate. So eventually the central bank (one way or another, gold standard or no) has to raise interest rates at least back to and maybe above the natural rate (which may not be the same as the old natural rate) which ends the boom (and maybe causes a recession if the central bank has to raise the market rate above the natural rate to turn inflation around).
Starts to sound much more like me. Sounds much more Friedmanite.
Bob: Aarrrr! You’re just a lad! It would be good to see your response. Must look up the Yglesias post.
Nick wrote:
Is it: C=a+bY(t-1)? Or C=a+bE(Y(t+1)) ?
It could be either. I had in my head just plain C, a number, any number, just like a resistor in a Resistor/Inductor/Capacitor circuit (that is a filter).
My systems prof would say that C=a+bY(t-1) is causal and therefore stable. In a casual system y(0) = 0 for t <=0 and anything else for t>0, so C=a+b(0) and C=a and varies thereafter.
In the case of C=a+bE(Y(t+1)), at t=0 you are getting C=a+bE(Y(I)) which is a look-ahead system. This is not a casual system and in look-ahead systems are generally assumed to be unstable in nature. They can have unbounded output for bounded input. Guessing is like that.
My model your function is akin to a potentiometer, the dial you adjust your dining room light with. If the dial looks back it is causal and stable, if it looks forward, you are on your own.
But either way, in the presence of two storage elements and a second-order flow circuit, if you adjust C you will get a significant “ringing” due to the transitory response.
Nick, the Wicksell/Hayek distinction is between permanent resources which can be used an infinite number of times in sequence (land) and non-permanent resources which are can be used only a finite number of times, i.e. are used up, (capital goods or production goods).
The deal is that in economizing across time, we have to take into consideration relative multi-good input and output tradeoffs where non-permanent resources are concerned. How often do we use that antique furniture and that Mazda MX6, how much money do we sink into the upkeep, safe condition, and maintenance of the furniture and car?
We have to make economizing choices and choices at the margin in our affairs concerning non-permanent goods, whose trade-offs implicate the value or output we get from them, and these choices have a clear time dimension that can be shorter or longer, e.g. we can burn the antique furniture for a winter fire or we can crash the car for kicks, or we can use these only as tools for important production activities, tell your own stories using furniture or a car.
It’s late and I’m tired and I’ll sleep on the question of hooking this all up to elasticities of demand and substitutabilities, which seem relevant.
The idea is if overnight your Mazda MX6 became indestructible and never again required repairs and would last forever and ever, it would become land and would no longer figure in our economic choices over time in the same what that capital goods / non-permanent production goods are economized over at the margins of input, time and output.
Determinant: “Come to think of it, I have just said that savings and investment may or may not be equal. I accept that they exist in some quantity and proceed to solve from there, but need two initial conditions to do so. You may be able to simplify down to a first-order differential if you accept S=I. I believe that may be the most treacherous and misleading identity in the whole of economic history for that reason.”
Is it an identity? After all, we have this identity (sic!):
(G – T) = (S – I) – (X – M)
If S = I is an identity that should really be written
G – T = M – X
No?
Yes. That is it, and so we have Hayek promoting something like NGDP targeting. Now my story isn’t the one you usually hear because…
1) One of Hayek’s big ideas was the local nature of information. Hayek is a definitely an Austrian, and a consequence of knowledge of time and place could be something like Klings PSST. So its right to say that’s an Austrian story, but it isn’t the story that whose pedigree goes back to Menger and Böhm-Bawerk. In other words, there are two stories, both Austrian, but if you muddle them together, nothing makes sense.
2) Mises does talk about the inefficiency of liquidating capital during the boom, but its more like, “oh yeah there are some other reasons this is bad for society”. The concept itself is an observation; it isn’t derived from theory.
3) Mises (and Rothbard) were virulently anti-socialist. Most of all they hated inflation because they viewed it as a form of tyranny. That meant first that they didn’t do much to clarify the argument for people. Second, also as a result of this Mises favored a gold standard. This seems mighty strange in light of the story I just presented.
Except the Mises’s gold standard is rather different: the CB has unlimited authority to print notes 100% backed by gold–i.e., by buying and warehousing gold bullion. That seems strange, but he proposes that the CB buy gold only at par (and the Government is obliged to sell it to the CB at par). If the price of market gold is above par, the government subsidizes the transaction from the general fund. It seems me that what this system means is that rather than the gold-miners setting the supply of money, what you have instead is that the CB sets the money supply (using a 0% inflation target) and the government subsidizes mining to ensure that gold production keeps pace with the growth in money demand. I find this complicated contraption as proof that Mises really did understand what you called Freidmanite story, but he was also politically anti-socialist and linked that up with the gold-standard because he didn’t want so-called socialist budget deficits funded to be funded by the CB. This scheme makes the government pay directly for inflationary excursions which is an interesting way of creating incentives.
Nick,
I don’t understand this:
“Yep. This post doesn’t really have any constructive argument that nothing is holding us (OK, I mean you, the U.S.) back from a normal equilibrium growth path. Though that is my belief. It is more of a challenge to others who say something is holding the US back. What is that “something”? And I am arguing that that “something” cannot simply be what happened in the past, because that would violate “bygones are bygones”. It has to be something in the present. (Or perhaps the expected future?).”
The past is in the household sectors balance sheets. The present is unemployed resources. This combination has changed the perception (and reality) of risk for lenders and investors alike. Unless someone insures that risk, the economy cannot grow because (risk free) interest rates have already fallen as low as they can. If you insist on ignoring balance sheets (and the implied risk factor built into them) – of course you cannot understand it.
Greg Ransom
“Nick, the Wicksell/Hayek distinction is between permanent resources which can be used an infinite number of times in sequence (land) and non-permanent resources which are can be used only a finite number of times, i.e. are used up, (capital goods or production goods).”
– sorry I don’t understand that distinction – surely that is a difference of degree not kind. Land still comes with maintenance costs. True it doesn’t become obsolete, and can’t be wholly replaced – but surely that is just an extra cost.
Isn’t there an assumption here that the stock of money equals the stock of real things? I can’t see that it does. Money is a representation – a picture – possibly of a real thing (or possibly not). The economy is people creating real things and turning some of them into money, but it is also people turning money into money, or money into real things (or, in the case of derivatives, turning money into money into money….). One can build up a lot of pictures that are believed to represent real things, until more than usual are found to be false – then it’s suddenly a game of musical chairs with several chairs short. So the past matters, as people cling to (past) hopes and dreams, hold on to old “pictures” hoping that one day they will again equal real things, create more pictures along old lines and so on. In short, any human system will have enormous momentum, as various forms of memory are intrinsic to their functioning – not just overt individual memeories, but the memories embodied in things, organisations, habits…
P.S. I really like Jesse’s post – I think he has it pretty right.
But just so everybody here knows where I stand – I think Greenspan booms were a response to another imbalance, not the cause of the imbalance. The US Trade deficit is hot trail that we should be concentrated on. Why could the US only maintain full employment via a series of irrational asset price bubbles? Because the US dollar was set so low, that there were hardly any other productive investments available (so you end up with gold rush type snowballs). After all, even if low interest rates encourage investment – investors will still try and seek out the most promising investments. Why did they choose to gamble, rather than looking for safe easy picking investment, that might now have been made affordable by low interest rates?
P.S. It seems to me that Austrian’s should ask themselves whether the undeniable fact of consumer credit, doesn’t complicate their story about the lengthening of the investment horizon with low interest rates. It seems to me, it wasn’t a factor in Hayek’s time.
oops
… because the US dollar was set so HIGH ….
And Nick – I think the distinction between land and capital is that capital is mobile (sometimes admitedly that mobility is very expensive). Land has a fixed position and that position is CRITICAL to its value.
Jon: you are making an awful lot of sense. ABCT is a mixture of Friedman + Arnold Kling’s PSST originally told in an institutional setting where any change in the money supply and price level had ultimately be reversed (though a similar story can be told outside that setting). Plus, the vague I-S=delta(M) idea is basically the Laidler/Yeager one I sketched out in my Wicksell and the Hot Potato post. It is all coming much clearer now, after 35 years of puzzling this over. Well done!
Greg: I think of farmland vs oil deposits. And hammers vs whisky. The first of each pair can be used forever, if treated carefully. The second is used up when consumed. I would say that’s an important distinction, but cuts across the land/capital distinction.
reason. Hmm. Mobility is also important, but some God-given resources are mobile. Oil and gas can be moved. Water too.
Also, can’t an area be flooded to dry out another area? I.e. the creation of dams involve the sacrifice of some land for other land and these are sometimes on a vast scale. That’s not quite “mobility”, but it’s close for many purposes.
Nick, as an orthodox priest of the Misesian/Rothbardian tradition, let me say that I view Jon’s remarks as heretical. So, you are obviously free to consider them on their merits, but I’m just saying I don’t at all agree with how he is saying “this is what Mises was really saying” etc.
(Jon, forgive me for just dropping that claim and leaving, but I don’t have time to wade through it right now. But e.g. when you say Mises says that the bust is caused by tight money, I think that’s very misleading if you’re trying to build bridges with a target-NGDPer person. I know what you are talking about, but I think the linking of the central bank to the onset of the recession is entirely different in both camps.)
And dams themselves are normally understood as capital, but can’t be moved.
Nick,
I agree dams, roads, railways etc (i.e. infrastracture) are another category entirely. And so are non-renewable resources (which unlike land get used up). So does our attempt to reduce all long lasting stuff to one single “capital” category make sense?
P.S. A a bit of a greenie and someone with some sympathy for the Georgian (i.e. Henry George) view of things – I think you may see where I’m heading to.
reason: the Henry George aspects to this question did cross my mind. Suppose we implemented a Henry George tax on land. Then we discovered that Prince Edward Island was in fact capital, not land. Would we suddenly scrap the tax on farmland in PEI? There is no economic difference between putting a tax on land and putting a tax on all land and existing capital, and promising never to repeat this in future on capital built after today.
“There is no economic difference between putting a tax on land and putting a tax on all land and existing capital, and promising never to repeat this in future on capital built after today.”
Hard to imagine that surviving legal challenge. And of course the point of Henry George is that the value depends on location (and externalitites associated both with infrastructure and other buildings, people and firms). The value of a machine is no so dependent on externalities.
And Nick,
saying that PEI is capital doesn’t affect MY definition of land as being location.
Let’s stick with Popper policy that “words don’t matter” here, we are interested in concepts to help us with different kinds of economic problems. We don’t want to be arguing over mere words,
“Greg: I think of farmland vs oil deposits. And hammers vs whisky. The first of each pair can be used forever, if treated carefully. The second is used up when consumed. I would say that’s an important distinction, but cuts across the land/capital distinction.”
Greg,
I’m sure you want to say something here – but what exactly escapes me.
reason — I don’t find you to be either particularly sincere or particularly interested in carefully reading what I write. So don’t be surprise if I don’t engage your “arguments”.
Nick, if we wanted to argue over words, we could re-write this as:
“I would say that’s an important distinction, but cuts across my land/capital distinction.”
Wicksell points out that many improvements of land become permanent features of the land, so the economics of “improvability” differs depending on what are improving, i.e. we can also improve petroleum, but it remains for all purposes I can think of a production good which is used up.
As Menger and Ricardo and many others make clear, words used in economics are technical terms whose meanings derive from economic functions in the logic of choice and calculation. We do with with all sorts of words. We are looking to identify economics useful concepts to help us with particular problems.
The economics problems and causal consequences of coordinating alternative uses of non-permanent resources is different than that for permanent resources.
The economic use of non-permanent resources takes us beyond a “manna from heaven” economy.
Permanent resources for the most part do not.
We want to think about the coordination of non-permanent production plans and resources across time because this is where productive economization takes place …
Across the boom and bust this coordination across time is demonstratively out of whack — a systematically selective set of non-permanent plans and resources loose their former economic relevance and former value position in the system of relations across time.
So a second reason we want to focus on the coordination of non-permanent resources used for shorter or longer production plans is to understand the character of discoordination when plans and resources are systematically discoordinated across time, with prices directly implicated across time are dramatically altered and when processes taking more or less time are dramatically shifted (e.g. the boom and bust in the extremely long production process of “providing housing to a family” represented by rocketing and then crashing home prices.)
I’ll stop there.
Greg Ransom,
don’t take my banter for unseriousness. But to be honest, I find your expression amounts often to what seems to me deliberate obfuscation. I must say I admire Nick for trying to deal with it and create a little clarity.
Greg,
and forgive my scepticism, but I find that making excessively definitive distinctions where there is in reality a whole range of subtle variations is one of the biggest sources of error in thinking.
Bob, I once took an entire class on the philosophy of causation in my early years as an undergrad. Let me weasel from the start and say: well that depends on your meaning of cause.
Mises supported the idea of a stable price level, so very plainly he does not put the animus of his argue directly on the act of tightening. He instead strikes at the earlier sin qua non: had there been no loosening, there would be no inflation and therefore no tight money thereafter.
You need to keep the mechanics of his model and his policy argument separate.
Second, I do view my presentation here as revisionist. It’s easy to misunderstand Mises if you don’t consider the preoccupations of the early 1900s. Mises is writing to a technical audience where you have on one hand peels act and machinations to stifle boom-bust patterns by controlling the issuance of notes and you have the real bills doctrine, which states that unlimited discounting of CP will never lead to a bust.
The big Austrian point is that any expansion of credit that will lower the market rate below the natural rate will induce an inflation and therefore a bust no matter the quality of the assets acquired by the banks.
Greg,
I wish you people would find another example than housing. I think this sentence
“(e.g. the boom and bust in the extremely long production process of “providing housing to a family” represented by rocketing and then crashing home prices.)”
is completely wrong headed. First of all it is not “home prices” that rocketed and crashed – it is land prices. Secondly the production proceess of providing housing to a family is not extremely long. Producing pharmaceuticals or refining petroleum – now they are extremely long production processes.
Sorry, “reason”, you have this wrong.
Intentionally?
Jon: so Mises was arguing the real bills doctrine was false, and that there could be an excess supply of money, even if the CB followed the real bills guidelines? Hmm. Mises is going up in my estimation.
A house is an extremely long period production good.
Here’s a short period production good — a sand castle.
Here’s another — a temporary stick and branch shelter in the forest built for emergency
Think about how additional time consuming production goods and processes are required to extend the productive time of the productive goods closer to direct consumption they can help create.
Nick wrote:
so Mises was arguing the real bills doctrine was false, and that there could be an excess supply of money, even if the CB followed the real bills guidelines?
Oh, for sure. Have you read The Theory of Money & Credit?
In thinking of output of a house as a long time production good with a long time choice horizon also think of the long time period inputs to that production good — timber grown for years, then harvested using equipment which which took time to manufacture, using equipment which took time to design and manufacture.
If people don’t want years of housing and just want a big fire, they could immediately burn down the forest at get that output, and not waste time building heavy lumbering equipment, machines to build heavy lumbering equipment, or waiting for the forest to mature, or building the house and maintaining it over decades and centuries.
“Suppose that geologists discovered that we all had false memories of the last decade. The houses that appeared in the US are in fact a very recent geological feature. They just sprung up out of the ground. There wasn’t any overinvestment in houses at all. God did it. God overinvested in land. Did God make us poorer by doing that? Would the recession suddenly disappear, when people learned the news?”
The problem is the debt taken on to build those houses. People borrowed a lot of money to pay extremely high prices. That is, they dedicated years of future income to a house, probably under the belief that prices rise forever, and it turned out to be a very bad investment. The prices fell, many people lost their jobs and their houses, and most people are still paying for it. Annul the debt and you will end the recession, at the cost of moral hazard. But if you ignore the role of debt, you are never going to see the problem.
It’s worth examining why people would ever take such extreme risks. Obviously they judged the alternative (not buying a house, sitting it out) to be an even greater risk. And maybe it was. In Canada housing never crashed and is rocketing higher and higher. We have surpassed the US on many metrics such as debt to income and price to rent. Anyone who sat this out for any reason is basically obliterated. It literally does not matter what kind of job or education you have if you’re under 35. Maybe it will correct, but maybe it won’t. Inflation is transferring mountains of wealth from savers to debtors, adding more and more cement to that gain or loss. For people on the losing side, it is a bitter pill to swallow, but the majority is happy.
The immediate cost of any policy favouring one group over another is moral hazard. People in Canada will continue to buy more and more houses until the policies are changed. Then we are likely to get a really big bust. But timing is everything. In China these policies were continued for 20+ years. Rich families own hundreds of empty apartments. Speculators can and do get incredibly rich. College graduates with professional salaries are packed 6 to a room and can not find wives or settle down. Vancouver is looking more and more like this. I think I will leave Canada before it turns into China.
Determinant: “Come to think of it, I have just said that savings and investment may or may not be equal. I accept that they exist in some quantity and proceed to solve from there, but need two initial conditions to do so. You may be able to simplify down to a first-order differential if you accept S=I. I believe that may be the most treacherous and misleading identity in the whole of economic history for that reason.”
Is it an identity? After all, we have this identity (sic!):
(G – T) = (S – I) – (X – M)
If S = I is an identity that should really be written
G – T = M – X
No?
It can be used as an identity in economics and frequently is, though as I said it really shouldn’t be. It’s much more interesting and realistic to assume that S and I diverge somewhat and see what the response of the system is. When you do that you will change the “resonant frequency” of the system.
My argument is to let S and I be, don’t force them to be equal and don’t use concepts that rely on S=I. See what the system does when they diverge. We call that a small-signal model.
When economists argue about the short run and long run, I read that as the transitory response of a system and the forced response of the system. Both are valid but they have different causes. The transitory response is based on the interaction of S, C and I and the income flow through them. The forced, long-term response is based on production and consumption, S and I disappear as direct factors.
Bob: I read both the Theory of Money and Credit, and Human Action. But ages ago, when I was but a lad. Yes, I should re-read TMC, but there’s a 100 other things I should read too.
Nick Rowe: “Determinant: simplify. Forget investment. What’s your consumption function?
“Is it: C=a+bY(t-1)? Or C=a+bE(Y(t+1)) ?”
Determinant: “In the case of C=a+bE(Y(t+1)), at t=0 you are getting C=a+bE(Y(I)) which is a look-ahead system. This is not a casual system and in look-ahead systems are generally assumed to be unstable in nature.”
May add my two cents worth? 🙂
In C = a + b * E(Y(t+1)), I assume that E() stands for expected. (I hope that we are not talking about mathematical expectation, though.) Since E(Y(t+1)) is not an observable (as I gather from these discussions ;)), then, in operational terms, what is the difference between that equation and C = a ?
I do not mean to suggest that expectations, in some non-mathematical sense, do not matter. But in order not to treat them as sources of error, don’t we need some kind of theory of expectations? If we have such a theory, then C = a + b * E(Y(t+1)) can be expanded to include more terms. C = a + b * Y(t-1), since Y(t-1) is observable, does not need to be expanded.
Consider a man dropping from a hovering helicopter. If that is all we know, we can predict that he will land directly below where he is now, with some degree of error. If we also know that he is wearing a parachute, he has some control, and our error is greater. If we also know that he is a sky diver with a sky diving parachute, we know that he has even greater control, and our error is even greater. We may also suppose that he expects to land somewhere, which may not be directly below where he is now. But without a clue about his expectations, all we can say is that our error is large. However, suppose that we know that he is in competition, and has a landing target. Then, no matter where he is (within limits), we can predict where he will land, with a smaller error.
I do not think that the question is one of causality, but of what we know and observe. To be sure, human expectations are affected by memory. But if you wipe out human memory, and we know nothing else about those expectations, the expectation term becomes part of the error. Now, if everybody forgot that we have had high unemployment for years, and forgot that house prices used to be higher, and forgot that credit card rates used to be lower, and forgot how high the debt and deficit used to be, and forgot stock market histories, and forgot that we had a financial crisis and forgot that we bailed out Wall Street, etc., etc., that mass forgetting would probably help the economy. But people are still out of work, and still in debt, and still facing foreclosure, and so on. There is still systemic memory, encoded in present facts.
I do not know enough to judge Determinant’s circuit model. But I do not think that the existence of an equilibrium invalidates it. Nor do I think, if we are in a sub-optimal equilibrium, that mass forgetting is enough to get us out. We still need to get money into circulation, no?
Here’s another very short term production good: a Jack-O-Lantern.
The longest part of the production process is manufacturing of all the inputs into the equipment used on the farm where the pumpkins are raised. The shortest part of the production planning and production streams going into the output of the enjoyment of the Jack-O-Lantern is the part of that time consuming process when the thing actually sits on the porch.
Exactly, Min.
S and I, as components that have time-forward and time-previous contracts, encode that systemic memory.
When you say “get more money into circulation” it is exactly what you should do. That is a positive input that will force the system to respond and transit to a different forced input state faster.
Even better if we can increase I and reduce S. In a second-order differential as a control system, I is the second-order term and S is the direct term. A system that has higher I and lower S is underdamped, it will have a faster response time to a new forced input. A system with higher S than I is overdamped and will be much slower in coming to a new state.
For expectations, what you are doing is predicting what C(t+1) will be based on C(t). Which is OK and will work but it has a significant chance of error. When I say there is a causality problem, I mean a system cannot directly read and process Y(t+1).
Reading the past? Easy.
Inter-temporal contracts are, like anything, great under certain circumstances but you have to be prepared for when you have suboptimal conditions.
Determinant: lots of very clever people have thought about really hard about this stuff. There is more to economic modelling than A-D. Off the top of my head as a rank amateur: try googling Barkley Rosser, also computation economics.
If you want to follow the advice of Sun Tzu:
http://cowles.econ.yale.edu/P/cm/m17/
It’s hard slogging to read closely (Bagehot is a Harlequin in comparison), but at least it’s not Hayek.
Jon: so Mises was arguing the real bills doctrine was false, and that there could be an excess supply of money, even if the CB followed the real bills guidelines? Hmm. Mises is going up in my estimation.
Yes, he definitely did that, but before you esteem him too highly in public, I’ll warn you that his handling of says law is quite muddled. This I think is the real weakness of my revisionist presentation. He understood that the money supply needed to be elastic, and he understood that tight credit induced the bust but connecting the two with a clear analysis that says law was wrong–that he has never had.
No the only clear explanation he gives for why production will fall below potential is Wicksell’s view that a rise in the market-rate retards investment activity. Its the interest-rate channel only. I don’t think Mises believed recessions could happen in a non-credit economy. This is how the story eventually degenerates into liquidation inefficiencies.
Hayek on the other hand got over this hurdle.
Greg Ransom
“Think about how additional time consuming production goods and processes are required to extend the productive time of the productive goods closer to direct consumption they can help create.”
So it seems you define production as consumption. You just speak a foreign language. So , if I want a very long term production process I should create children. Is the birth rate negatively correlated with the real interest rate?
Greg,
I guess I sort of agree that in a sense consumer durables are productive capacity (although – apart from houses – not in the normal national accounting sense). But from the point of view of dividing the world into producers and consumers, this is irrelevant to a producer. His interest ends when he sells it. Stories about running out of builders materials then are beside the point. And the house doesn’t in any sense become unsustainable – it keeps giving shelter. (Particularly in the case of housing because most of the adjustments are made in land prices). There is any real “unsustainability” issue – only a financial one (which potentially has a financial solution). Why do you want to insist on a real solution to a financial problem?
P.S.
By the way, I’m of the belief that the excess building of houses – while real – was relatively minor and in normal circumstances would have already been corrected. The major problem was the excess price paid for the land they were built on and the debt taken on for that land. So real resource misallocation – small – asset price bubble – major.
P.P.S.
I’m a total heretic in that I think the idea of single stable economic equilibrium is an irrelevant myth. So worrying about deviations from this are also pointless. If there was a shortage of investment leading to deflationary conditions, then investing in better houses is not stupid thing to do (people always want better houses). But the land price bubble was destructive of the financial health of the household sector. Land price bubbles need to be better understood, and we need better policies (particularly on the supply side) to counter them.
Nick: “There is something logically peculiar about the Austrian theory of recessions, as being caused by past overinvestment. Sure, the natural rate of interest would be lower, and the future pattern of investment would be different, if a lot of houses suddenly sprang up out of the ground. But isn’t the market supposed to be able to handle things like that”
I am no Austrian myself, but as I understand the key point for the theory is malnourishment of particular phases of production process (capital formation). So I think that according to the Austrian story, even if we would see houses sprang up from the ground, the problem with depreciation of capital in some stages of the production would remain. That means that even if you wake up with total amnesia and somehow get to work (maybe you have the address of your employer in your phone), you would find that your production tools are damaged and you would have to wait for them to be replenished. Presumably, waiting for this as one of the unemployed. So that is only a different way of saying the usual structural story.