 Okay, ladies and gentlemen our next lecture this afternoon is going to be given by Dr. Roger Garrison from Auburn University and The title of his lecture is on the Austrian theory of the business cycle Roger Okay, I think this is a fifth lecture that you've attended today, so you're all gluttonous for punishment I appreciate that appreciate you're coming to still another lecture, but there's what two more so A long day The official title of this lecture is Austrian theory of the business cycle in my book I generalize a little bit call it capital-based Macroeconomics, I think the Austrians have a full-fledged Macroeconomic system the best developed part of it undoubtedly is the Austrian theory, but my of the business cycle but my book contains fiscal policy and all sorts of other applications of capital-based macro economics I like to give you a little roadmap at the beginning just to show you where we're going and Put this theory in perspective in one way to do it is showing you the what I call the elements of Capital-based macroeconomics and it goes like this Some of the elements are just off-the-shelf Graphical devices that the Austrians can put in use in a way that the Keynesians Can't and that the monitorists don't okay And the first among them is this production possibilities frontier. I'm sure if you've taken Econ 101 you've seen a production possibilities frontier That shows you a trade-off Between one thing and another you can't get more of one thing without giving up some of the other And you'll see that that's a unique in certain respects to the to the Austrian theory The loanable funds market is a market you've heard about already from Jeff Herb and or and possibly others It's simply the market very broadly defined that brings into balance the Supply and the demand for a loanable funds And gives us a market rate of interest market clearing rate of interest more about that shortly Something called the structure of production is very unique to Austrian theory. You don't find it in Keynesian theory You don't find it in monitorist theory capital has a structure to it as Professor Herb and her has detailed in his lecture and stage specific labor markets if you've all taken macro In from one textbook or another in different schools of thought You usually integrate something called the labor market as if there's only one and it turns out that in capital-based macro we have a Several labor markets that we have to keep separate Depending on what stage of production the labor is working in so those are the Elements of capital-based macro. We'll see how to put them together in what I think is a particularly illuminating way and Then applications of capital-based macro or at least of the business cycle theory It goes like this so we can portray sustainable growth and What we'll see is that sustainable growth is based on your willingness to say Think about what saving means you go to work and you produce stuff You get paid for it. It's called income and you don't spend all the income you save part of it That means essentially that you didn't consume as much as you produced and that difference is real saving It's it's the stuff you produce that's available for Expanding the productive capacity of the economy Business people take command of that saving if you save it in a bank They borrow it and use it to buy those unconsumed resources to expand the capital base that gives you sustainable growth That's one application. In fact, we'll actually probably spend more of our time on that application and once we do We'll see that the other application is Really just a corollary a corollary. It's unsustainable growth, which turns out doesn't involve Increased saving in fact it involves decreased saving, but it also involves credit expansion and so Growth based on credit expansion turns out not to be sustainable. It turns out to be a boom That contains the seeds of its own undoing and causes the economy to Collapse we've seen it several times in the last few decades and saw it big time in this last Financial crisis Okay, so let's see where we go from here. I Don't need to spend too much time showing you who come up with these ideas It's a mesis and hyac and but it's interesting to note that this Austrian theory Was stated pretty concisely, but pretty thoroughly to at the same time by mesis as early as 1912 and we're talking about decades before Keynes Wrote the general theory and it was developed in the 1920s and into the 30s Mostly before Keynes wrote the general theory. So it was a it was a competitor of Keynes view and actually preceded it By some years, I'm going to introduce one methodological precept that Commands a scent I think just on reading it and this is a paraphrase from hyac And he says before we can even ask how things go wrong We must first explain how they could ever go right And what you'll see in this lecture is that I'll spend most of my time Showing you how things could go right and once you understand that That is pretty easy not only to see how they can go wrong, but to see the particulars of they're going wrong And how it manifests itself as an artificial boom followed by a bust This is a methodological maxim That is observed in the breach as they say Keynes didn't address the question of how things could ever go right Because he didn't think they ever could he didn't think there was anything in the market system That would allow savings to be brought in line with investment at full employment That mechanism just wasn't there And therefore the possibility of things going right wasn't there. So he didn't spend any time on it If you look at the monitors theory You see a tacit assumption that things go right. Okay, there's a Monitorist are very market-oriented They think markets work But they don't begin their macro theory by showing Just how so they can go back and show what might go wrong So it's the Austrians that take up this preliminary question With all degree of seriousness So I'll start with this production possibilities frontier And you know what it looks like You have two axes. I've got Consumption on the vertical axis. I hope you can see it. It's a little bit dim lights in here are kind of bright Consumption on the vertical axis and investment on the horizontal axis We can spend time explaining why it's bowed Outwards, but you probably know about that in any how the more important part is it slopes downward in other words You can get more consumption, but only if you give up some investment or you get more investment But only if you give up some consumption That's the PPF Now even at this early point in the exposition you see a huge difference between Hayek and Keynes How many have had a basic course where you learn Keynesian theory you learn the Keynesian cross so I hate to see that but What you what you remember about it is consumption and investment Rendered C and I or C plus I you add them together You add them together and the significance is that it's spending and for Keynes It doesn't really matter who spends what they spend on just so you get plenty of it consumption spending plus investment spending In the Austrian case you look at you look at the trade-off between using resources for consumption purposes and using resources for investment purposes Okay, now since under favorable conditions that means markets are allowed to work essentially The economy will find itself at some point on the PPF now. This is macro so the point on the PPF is a point of so-called full employment and You all know from taking macro the full employment doesn't mean zero percent unemployment That's it means the natural rate of unemployment. That's Friedman's term, but it's a good one Which is to say five or six percent Unemployment of people just looking for jobs between jobs just out of college or whatever So it allows for some unemployment a healthy economy has some amount of unemployment and I stress this Because I'll show you an exception even at this early point to the PPF that the PPF Essentially says you can't go outside of it. Well, it doesn't quite say that you can't go outside of it on a sustainable basis The economy can't be pushed below full employment level of unemployment On a permanent basis it can be pushed that way Temporarily in fact, that's that's part of the essence of the boom So it's possible to push the economy beyond the PPF But now sustainably it'll come back to the PPF and maybe even go inside of it So I'll alert you to that aspect of the model even at this early stage And here just a reminder the PPF shows up in all the textbooks. It's in the early chapters It gives a workout in micro It comes up in growth theory or in comparing one country with another in terms of investment and consumption But you never see it integrated with the macro model and that's what I'm doing here today. I'm bringing it in in a macro relevant way It also shows this difference between IAC and Keynes our CNI trade-offs or our CNI just two ways of Spending okay The investment there is on the horizontal axis That's gross investment. That's where the macro books are written gross investment And it shows you about that magnitude that horizontal distance is gross investment A lot of that though is making good on depreciation capital replacement obsolete machines that have to be replaced and so on and so a Big part of the gross investment is I call it replacement capital Making good on capital depreciation wear and tear and obsolescence breakage and and so on maybe as much as 70% or so total investment in a year is of that form but typically in A healthy economy There's some investment Above and beyond that okay, and that's net investment Which of course is the difference and that investment is a net addition to the Capital structure in some way or another it's it's an enhancement of The capital that allows for greater levels of production Than we had before Which is to say That if you have positive net investment The economy will be doing better next year in other words the trade-off will allow for both more consumption and more investment this PPF is Based on a particular year next year things will be better Simply because you've gotten that investment Okay So that outward shifting of the PPF it that's sustainable growth is based on your saving That represent resources that you created and didn't Consume They were taken command of by the investment community by borrowing your saving and Put to use in expanding the capacity of the economy to produce okay, so that's what we want to understand It says watch the economy grow Okay, you can hear the economy grow okay the economy grows This is the market at work Okay, for you and for me Okay, and it shows you about four steps And at that level We have a more prosperous economy The actual rate of expansion depends on a lot of things Capital depreciation increases too There might be technological innovations that they give a boost to growth There may be Other sorts of changes. It may be that people with higher incomes Choose to save even more of their income and cause the economy to grow faster It's a historical fact if if not a Praxeological truth that his income Rives the percentage of saving tends to increase so the faster it grows Grows faster still and so on I've ignored those second-order effects What that says there Okay, now importantly, that's a word I probably should have underlined a change in saving Preferences which provokes the moving along the PPF effects of rate at which the PPF expand Expands outward and this seems kind of unremarkable I suppose people become more thrifty more future-oriented. Okay, so they save more than there's more That Investors could borrow there's more resources they can take command of the economy grows still faster And I say importantly only because other schools of thought tend to ignore this Keynes for one argued that People save exclusively on the basis of their Current income he didn't allow for changes in Saving preference that was no part of his story and one of the things the Austrians do is they That's a choice that people make and they can make different choices at different times and they can certainly decide To save more okay says watch the movement Along the PPF if people save more it means they're consuming less and so The economy was going to move along that frontier in a clockwise direction. Let's watch it. There it goes Okay, it doesn't seem remarkable I mean it There stands a reason from the very definition of the PPF that you could move along it that second P and PPF Means possibility it's possible to move along the frontier and you just saw it move It can do it It doesn't do it though in in Keynesian theories And of course With saving and investment greater now the economy grows, but at a faster rate Okay, so here we go now watch the economy grow and you can see it's bigger steps Jumping out there farther each time because you started off with some saving We can even compare It's that increased saving that made the difference and you can compare with the old trade-off before that increase in saving and what you see is that With the without the initial increase yeah, you've got an expansion But with the initial saving You got a big boost there, so some saving Which gave Gave the growth rate a little kick And the economy grew faster And you can see that if you compare one with the other after four Years in this particular illustration people are now consuming more than they would have consumed had they not saved In the beginning now I'm at risk here of sounding like your parents You people should save more, you know, it'll be good for you. You'll wish you had you know Listen to me No, no, that's not what I'm trying to do My ex point Mesa's point was that the economy grows in accordance with how much you're willing to save save a little It grows slowly save a lot it grows faster, but you make the choice. Okay consumption is good, too All right, so you make the choice and the choice you make Will determine how fast the economy grows if I wanted to give you an admonition I would say don't save a little and Then vote for politicians who pledge to grow the economy That's a formula for disaster Okay The market for loanable funds and here we're looking at the interest rate very broadly conceived the most Explicit Manifestation of loans will be a bank loan you borrow from the bank it lends you money you borrow the money. That's it But really we're talking about all sorts of ways in financial markets that your saving gets transferred to the entrepreneur for Investment purposes, right that's how broadly defined it is and The saving of course slopes upward like all other saving curves The more interest you can get on money you lend The more you're willing to lend okay, it's true for you and for banks and so on the demand of Course is downward sloping it means entrepreneurs are More likely to borrow money to invest if they can get it cheap And this is a supply-and-demand curve like any other and if markets are working right Then we get a market clearing rate of interest And an equality between saving and investment that's what That equality means even in Keynesian economics you end up with an equality between saving and investment It's just not one that's brought about by changes in the interest rate according to the Austrians That's how you get that equality between saving and investment by appropriate adjustments in the interest rate Let the market adjust to its own level And that will get you the equality right and beware of Policymakers who manipulate the interest rate because that's the thing that will throw the economy off for sure Okay, it's interesting that an old Austrian economist Bo Maverik and Keynes Agreed that this market is defined in such a way that the horizontal axis is what it represents Investable resources. Okay, those are the investable resources that the entrepreneurs take command over And that were made available by the fact that you didn't spend all your income Okay, you saved instead and they took command of it. So that's what that's all about That's invest investment and saving measured separately on the horizontal axis the rate of interest on the vertical axis right Here I'm just showing you that that market for loanable funds drawn just as I drew it here is associated with Dennis Roberts and a British economist critique a critic of Keynes A friend of Keynes at least early on But Keynes wouldn't take all that much criticism. And so he didn't really remain Life-long friend, but that's Dennis Robertson And another important thing to also come back In a second lecture I give tomorrow is that when Roy Herrod Another colleague or not colleague, but friend of Keynes Read the manuscript of the general theory. He was dumbstruck thinking my god Keynes has rejected the loanable funds theory of interest and it turns out that Keynes had and Herrod convinced him that gee if that's what you're doing you better make it very explicit And so this diagram How many have thumbed through the general theory anybody in here you look through the general there one thing you notice There are no graphs you'd think there'd be a lot of graphs There are no graphs in the general theory none except oh except one except one and that's it The loanable funds theory he put it in cuz Herrod told him to and he put it in to show that this is what he's throwing out Okay, that was the story So it's essential to the Austrian view and gets thrown out In the Keynesian view now here With the loanable funds theory let people become more future-oriented assume that preferences change in favor of Saving rather than consuming today so that they can consume more in the future All right watch the saving curve shift rightward. You think it can do it? Of course it can this is the market at work Okay, it shifts rightward it lowers the rate of interest Market has been down to a lower rate of interest and it Gives the incentive for entrepreneurs to borrow more funds and undertake more Investment activities at low rates of interest investment activities are profitable that weren't profitable Before that's the way Markets work. Okay, so the interest rate goes down the amount of saving and investment increases That gives you again sustainable economic growth. We're showing now just how you know how the market actually works, okay And here I'm just showing you that the two views I've given you are just Two perspectives on the same thing that's going on so we can put them on the screen at the same time They look like this and they line up because that horizontal axis is investable resources in both diagrams all right So the loanable fund shows that the interest rate brings saving and investment into balance with one another and the PPF shows what the trade-off is between investment and consumption right now what I want you to do oh It just an almost a footnote markets adjust Adjustments and output prices wage rates and input prices keep the economy functioning on the PPF that's again say the market is Presumably working in all those dimensions right, so these two graphs together can show you a more comprehensive view of The effects of an increase in saving As before we're going to Suppose that people get more future oriented in their thinking And it says watch this Saving induced decrease in interest rate and corresponding movement along the PPF what you have to do is turn your head sideways And one eye look at one graph and the other eye look at the other graph, so let's watch this Okay, so everything lines up. I mean this is a little bit of harmony in the economic harmonies here that It all lines up more investment both places the interest rate fell to bring along the PPF You stayed at full employment because wages are adjusting and so on And that's what that says there. We don't need to read it Now this is important to recognize that Even the possibility of that happening was denied by Keynes Note that the investment undertaken is positive and yet consumption has fallen Okay, well, of course, I mean that's that's what it means To move along this negatively slow PPF you give up one thing in order to get more something else You're really giving up current consumption in order to get more future consumption And the way you get more future consumption is through more investment which is brought about by the lower interest rate that That was brought about by your increased saving. I mean it all it all fits Together and this last paragraph is a reminder. Let me apologize for reminding you of this but Remind you of what the Keynesian Scenario is And according to the Keynesian scenario. Oh if people reduce spending Then that will reduce investment if you can't sell this stuff You've already got on the shelves why bill I make more of it and if it reduces investment then Reduce you know investment then that reduces employment and that reduces income and then income reduces Consumption some more and it keeps reducing the economy spirals down. It doesn't go along the PPF. It goes inside the PPF Okay, that's what Keynes said and in fact it even happens has a name is called the paradox of thrift don't save Don't save because your reduction in spending will throw the economy into depression That's Keynes. That's the paradox of thrift Hyak is there to say if if markets are working if markets are allowed to work It will move the economy along the PPF Okay Now there's certain plausibility to Keynes and I think what we can say is if he's simply talking about inventories at retail investment in the form of Stocking goods on the shelf then surely he's right that if if people quit going into Target as much as they were before and they're not buying stuff on the shelves and the shelves Are just full of merchandise and don't need to be restocked. Well target will cut back on how much merchandise at order and So it's true that investment in the late stages of production move with consumption I probably say that there Y'all says it in the top paragraph but then in the next paragraph said there's another effect There's another effect a different effect and that's the reduction of the interest rate If the interest rate is reduced it makes long-term investment Getting wicked out there It makes long-term investment more profitable reduces the rate of interest increases the willingness of investors to borrow And build the capital stock and so it moves in the opposite direction for early stage Investments and this is what we'll have to do next here. Let's see to keep track of these changes We need to say something about the structure of production. That's why the structure of production Comes into play and here I'm going to take advantage of Professor Herberters lecture where he talked about minger I'm not sure he mentioned minger's law, but I can show you what that is easily enough And he talked about orders of goods he talked about goods of the first order That's consumption goods. It turns out and then goods of higher order. There's second third fourth fifth sixth seven I put him in that array. But so the seventh good will be highest order Okay, and look at that goods of the first order. That's just consumption goods and the rest are Intermediate goods higher order goods All right Now what I'm saying is that kane's reasoning about the paradox of thrift is true if he's talking only about goods of the second order In Little less true for goods of the third order And by the time he gets up to this fifth sixth and seventh order. He's got it backwards because those orders Are seriously affected by the low rate of interest. Those are long-term Investments that'd be a long time before They show up as consumption out to it And they're particularly interest rate sensitive simply because they're long term And so those get a stimulus all right Now In order to get back to my own representation here. Well here is minger's point He was doing battle with the classical economists with ricardo and so on that was still the dominant view of of his day of minger's day And and ricardo had a cost of production theory about of value. It's is because of the costs incurred That the output has value minger turned that around he says no, it's true that production takes place In time from the highest orders down to the lowest orders But the valuation goes the other way In other words, it's those goods of higher orders that get their value From the prospective value of the consumer goods. They will produce so he he reversed that belief Big part of the marginless revolution and minger's part of it Now what I do now is show you that Hayek put some analytical legs on this thing and what i'm super imposing here Is a page out of hayek's prices and production Instead of talking about orders of goods. He talks about stages of production. Okay orders of good becomes Stages of production and it looks like that and he drew it that way And so he had the production shown from top to bottom and then the horizontal component of that last the last leg or the last element Is the level of consumption? Okay Clean that up a bit looks like that the one thing that bothered me about that diagram It's just a partly an aesthetic thing and partly Making it aligned with my other graphics Is the time element in hayek is on the vertical axis And time is coming down the vertical axis. That's rather strange Wouldn't it be better to have time going left or right along the horizontal axis? Is there some way to do that? Is there any way to do that? It's easy, okay, you do it that way and when you do that then Again, this is the hayek in triangle production time as a sequence of stages goes left to right along the horizontal axis and if we Superimpose a triangle. I mean that is the famous Hayekian triangle Which which really just sort of almost an iconic symbol Of those stages of production. It looks like that. Okay. Now I'll go back to my own rendition and The capital based macro requires us to look at this temporal structure of production And we do that here. I'm going to use Five stages. Actually, that's what hayek used Five stages. But once the economy had grown a few pages later, it was up to seven Stages, which is what I used in the earlier Graphics, so there's stages of production along the horizontal leg and that consumption on the vertical leg It's not a vertical axis. It's it's the height of the vertical dimension of the triangle in other words The other vertical lines between the stages are the value of the output of that stage And the final stage the value of that output is the value of the consumption Goods. Okay, so that's the way it works now There's an early stage production that might be something like product development And a late stage production that's inventories at retail And kane's argument about paradox of thrips. It applies to the inventory management, but then apply to the Product development option Okay Because it's early stage and is influenced by the interest rate I use five stages and recognize that those stages mean mean two different things Really one of them is that those are things going on in the economy at any given point in time If we took field trips in here We could go out and about and see mining operations and timber operations and manufacturing operations and transportation Stuff and some retail and they're all going on at once but the alternative Interpretation as they show that sequence so in other words for any Stage at this point in time the the associated consumption output will be removed in time. So the the Goods are moving through producer goods are moving through the stages of production. Can we do that? Yeah, okay, they move through the stages of production. I didn't like the way they move That's my sound. Okay Uh, now remind you that this was the analytics clear back in 19 1931 When Hayek gave his prices of production, which was the same year that Henry Ford was still producing the Model A That's how long ago it was And Henry Ford was kind of person, you know, he didn't just produce automobiles. He actually owned the mineral rights To get iron ore out of the ground and make engines and he had almost the whole Shabang there. So if if Hayek had had PowerPoint, he could show you how the Model A's were produced, you know Go something like this Yeah, it works Okay Better move along here Uh So this is the summary interpretation this structure, of course much more complicated as Herman are Uh explained Um And we're showing here just linking up with the ppf that when the ppf expands just as a matter of secular growth We're not talking about a change in the interest rate here the The triangle increases in size as well. Okay This is secular growth. In other words, it's not induced by a lowering of interest rate or it's not induced by credit just ongoing growth Because people aren't spending all of their income In the current period More importantly when they save They send two signals that seem to be conflicting if at least if you have a kinsi and mindset And this it decreases The demand for inventories But at the same time it increases the demand for longer term projects Uh and so reduced interest rates means more investment in the early stage less investment In the late stage. Okay. And so it's really conflicting Only if you take kins model as the standard model c plus i plus g does i go up or does i go down? Well The important thing is that some i goes up and some i goes down. That's the disaggregation That uh that hayak paid attention to Okay Now This is just a reminder of that Says what's the structure of production respond to an increase in saving? What do you expect you're going to see? You're going to see Less investment in the late stage more investment in the early stage. Let's watch Resources are just moved out of the Late stages and into the early stages. All right. That's the way it works Okay, we can even show that with the ppf. Okay And again, you're good Very consistent moves and move along The ppf. So you're getting more investment Okay, more investment and disproportionately more in the Early stages in other words investment actually goes down In the late stages and up in the early stages. So you get that relative effect. That's important to the austrian theory So the structure have more of a future orientation But that's completely consistent with your preference change You want to save now to be able to borrow more or to be able to consume more in the future So so the market mechanisms are perfectly aligned With your preference change All right, watch the economy grow more rapidly. Okay, so now it's growing more rapidly and I think it's instructive to to look at it in terms of just uh Plotting consumption against time And what you can see is economy was always was was already growing And then at some point you decided to save more So the growth slowed down or even went negative for a short time and then turned positive But at a greater rate. Okay, so Here is showing you that First consumption goes down and then it goes up at a higher rate. It shows that with the uh Triangle too it goes down and then up at a higher rate. Look at it on on the grid below Goes down and then it goes up at a higher rate So what that means when we track consumption over time Is it ends up going higher than it would have gone? Had you not saved? In the first place see that'd be the old growth path there And so the trade-off that's really being made is a trade-off between consumption in the Near future that cross has area and consumption in the more remote future. Well, again, that's what your Saving is all about. I'm starting to sound like your father again, but that's that's what it's all about. Okay Now I can go through this pretty quickly stage specific labor markets its movement in the labor market That helps bring this result about and all I'm doing here is replacing my pictures of a few slides ago instead of showing Somebody in product development. I'm showing the labor market in that area or instead of showing retail inventories I'm showing the labor market in that area And I could have three more labor markets if I have enough room on my screen, but I don't It's all make do with two the point is that those labor markets respond differently to a reduction in The interest rate All right, and not surprisingly you get a reduction in demand for labor at the Late stage in and an increase in the demand for labor at the early stage in Okay So let's watch this and see how it works Watch the economy respond to an increase in saving and watch the labor market really because you've seen the other So see the demand for labor at retail goes down the demand for labor at product development In extraction industries in any kind of long-term project real estate is always interest rate Sensitivity in prices and production Hayek even mentioned what he called a wage rate gradient You can see it there that while the economy is adjusting to the new structure That wage rate gradient is what pulls workers out of the Late stages and into the early stages. That's the way the market Works, okay Now we're ready for something of a grand finale and we haven't got the business cycle shed, but we'll get there and it'll be easy I'm showing you the whole shebang. There's there's the whole model And this one I pulled a trigger on this one. I'll have to watch y'all watch the economy respond to an increase in saving And what you're going to see I think this is my humble opinion is poetry in motion. I mean this this thing works Okay, so watch it respond in all the ways that you would expect okay increase saving reduced interest rates moving along the frontier reshuffling of resources towards the early stages labor markets that help bring that about Which will give rise in the future to higher levels of consumer output In accordance with people's willingness to save now in order to consume more in the future right I put this up here This is steve hanky And I want this quote from hanky even though he's actually drawing from my book time and money I want this quote from him because he looks more stern than I can look. I can't look. I can't do it I can't do it But you're going to believe this guy when interest rates with interest rates artificially low consumers reduce saving they reduce saving Okay in favor of consumption and entrepreneurs increase The rate of investment spending and then you have an imbalance between saving and investment You have an economy on an unsustainable growth path This in a nutshell is a lesson of the austrian critique Of central banking developed in the 20s and 30s So in other words, this is a prelude now or just an introduction to how the market works badly when It's not allowed to work on its own when it's working under conditions of proactive interest rate policies by the federal reserve Credit expansion That's just a loanable funds market again, but I'm going to do something different with at this time Um We're talking about new money. This is this not saving. This is new money new money Masquerades of saving the supply of loanable funds Shifts rightward, but without there being any increased saving All right And so I want you to see how radically different this is we're not talking about the market for work At work for you and for me. We're talking about a policymaker Um That Got his hand on the supply of loanable funds. Okay. Is this going to help us out? He's going to help us out Okay Well, no He increases The amount of loanable funds and notice it's not s plus to s prime is s to s plus delta m In other words, it's just new money coming into the system To give you that low interest rate all right And when that happens People respond in predictable ways So pumping new money through credit markets drives a wedge between saving and investment So the investors are moving down along their demand curve in other words Interest rates lower they want to invest more but savers Are moving down along the supply curve in other words. They're saving preferences have not changed And the interest rate has fallen so they think we'll save less. Thank you very much Why bother to save at that low rate might as well go ahead and consume In micro that would just be a shortage And it would cause the problems immediately But in macro as applied to loanable funds It's not a shortage because what would have been a shortage is made up by guess what newly printed money Okay, so as the federal reserve here there's papering over the shortage With the newly created money now, of course, if you have any instinct of an economist at all You know, that's not going to fix things as that's just going to postpone The ultimate reckoning and so instead of getting an immediate shortage You get a festering this equilibrium that eventually causes the economy to collapse into recession or worse right So this is much of hi-hack's writing uses this loanable funds framework, but he doesn't draw the graph. Okay, he doesn't draw the graph But i'm sticking pretty close to hi-hack here Now we can trace upstairs here And see what happens you get really a double disequilibrium look at it from the consumer's point of view first That uh, i'm sorry the investor's point of view first They want to invest more so they think in terms of Moving rightward as if the economy were being pulled along the ppf in that direction Consumers are headed the other direction Right, this is not equilibrium. It's it's a disequilibrium, right? If we look at the axes we see that what's really going on here is that consumers are pulling northward and Investors are pulling eastward. Okay, because that's where the axes line up And the and the resultant force On that is to push the economy beyond the ppf of Do sort of a virtual equilibrium up there that you not going to get to you're not going to get there You're not going to stay there even if you could get there But for a time the economy gets pushed on push beyond the frontier Which means the unemployment rate gets pushed down below its natural level You got more people working than would in ordinary healthy economy and they're producing capital goods are producing consumer goods and the economy is booming okay, if you look at The structure of production it's getting conflicting signals on the one hand the low interest rate is suggesting that we need more higher order goods But the the spurt in consumption because people aren't saving now Drags resources in that direction too. So it's conflicted For loanable funds, we call it a it's a wedge between saving and investment or ppf is a tug of war between Investors and consumers for the triangle I'm indebted to John Cochran of metropolitan state for calling it the dueling triangles. Okay, because the the the the signals are conflicted Okay, now the result is you get over investment you get more investment than you otherwise would but More significantly and this is the Austrian flavor you get malinvestment which means a term mesis used to describe too much investment in the early stages You get over consumption Pushing beyond the front here in the upward direction and you get that in the ppf or in the structure of production as well In fact down here mesis repeatedly uses the phrase malinvestment and over consumption As characterizing the boom and that's what he's talking about. All right, now The tug I mean look at the language here. It's not the it's not the language of the market working for you and for me It's it's the language of market forces that war with themselves Due to the intervention of the central bank the tug of war that pits consumers against investors pushes the economy beyond the ppf the low interest rate favors investment in Increasingly binding resource constraints keeps the economy from reaching The extra ppf point. There's a virtual point up there. They're not going to reach it So how does this play itself out? Temporally conflicted structure production dueling triangles eventually turns boom into bust and the economy goes into recession and possibly Into deep depression. Let me call your attention to the orange Arrow up there in the ppf you're pushing outward but with Investment bias because of the low interest rates But eventually the resources available won't support that rate of growth And the economy turns the other direction And falls into deep depression Okay, that's that's the theory now one thing that's interesting about this is that if you look at that long orange arrow And you have to realize that that's the only part Of the analysis that kane saw And all of all of the kane'sian theory is about the economy moving up or down along that long arrow. He doesn't see The mall investment because he doesn't have a structural production I'll put it all together here. We're just about through we'll make it Put it all together here and This looks like a management course or something because I've got three p's but I can't resist Adding the supply of loanable funds with new money drives a wedge between saving and investment Papering over the difference between saving and investment Gives play to the tug of war between consumers and investors Pitting early stage against late stages Distorts the hierarchy and triangle in both directions the temporal discord nation eventually turning boom into bust That's the essence Of the theory You can watch the business cycle unfold it looks something like that Okay gone You wouldn't do happy with greenspan, okay A lot of people are too young to recognize this next guy anybody know who he is Joe the plumber in other ways the ordinary business man in ancient people get as strange, you know messing up your economy Look at it in its simplicity. Here's the market at work for you and for me Increased saving versus credit expansion to summary comparison first saving supports genuine growth watch So again, there's the poetry in motion with the market working right Credit expansion triggers boom and bust watch Yeah, I got time for voices in the wilderness just to show you that this this theory Yeah, I got this theory. It's not universally ignored. It's almost universally ignored But not quite and I've already showed you Steve hanky informs Early in 2008 saying here's what's coming down the line. We know it because of the austrian theory Here's some more voices the economists This was back with the dot-com boom Buzzed the economist editorial view is a recent business cycle in both america and japan has played many austrian features, okay, it wasn't kainzine. It wasn't monitors. It was austrian land hoofing uh swedish economists book with sympathies for the austrian school and he's writing in 2008 This is operating an interest targeting regime keying on the cpi. So he's saying the feds manipulating interest rates The fed was lured into keeping rates far too low for far too long the result was Inflation of asset prices now, that's not just plain old price inflation Certainly inflation of the money supply But he's saying that the that the rising prices affected The early stage the asset prices not the consumer prices so much the result was Inflation of asset prices combined with the general deterioration of credit Quality so he's got risk factors in here which we can easily factor in this of course does not make a kainzine story It is rather a variation on the austrian over investment theme And one more i don't know this guy who in here does he by no foresight have you seen On uh on fox. He's writing here for Barons look what he says But the austrians were the ones who could see the seeds of collapse in the successive credit booms Aided and abetted by the fed policies, especially under the former chairman Alan Greenspan who got huge kudos when he retired by Milton Friedman by the way But he disavows again Greenspan disavows again The responsibility for the boom and busts most recently on wednesdays wall street journal op ed page The monetary policy played a key role in creating successive bubbles And busts during his tenure of 87 to 06 Hey, that's my book Okay, thank you much