 Our last lecture this afternoon is Dr. Roger Garrison and he's going to be speaking to us about the Austrian theory of the business cycle. Roger? Yeah. Thank you. I used the title the same thing was on the program, the Austrian theory of the business cycle, but I'd like to point out that the graphical apparatus that I'm going to present is actually much more broad than that and I could easily change the title. I didn't change the title and I've obliterated it. To capital based macroeconomics, that's what I've been calling it lately and that term is caught on to some extent. But if you look at my book, Time and Money, you'll see there's only a couple of chapters devoted to expositing the Austrian theory of the business cycle and other chapters use that same apparatus to deal with deficit spending, spending on infrastructure, credit control. In fact I'll show you how that works even in this lecture and even tax reform. I've got one section of a chapter that shows using this apparatus what would happen if we were to reform in the direction of a consumption tax instead of an income tax. So the apparatus is very versatile. Although the main application I think if only because this is what the old Austrian economists have stressed is the business cycle lecture. I subtitle it Sustainable and Unsustainable Growth, Macroeconomics of Boom and Bust and that's a tip off from the very beginning that a business cycle is simply unsustainable growth and it turns out the reason it's unsustainable is because it's fueled by created credit as opposed to being supported by voluntary savings. So I don't want to save my punchline to the end that's it. That's what you're looking for but if you know what you're looking for then you're more likely to see how it all plays out. I have one slide here where I just lay out the particular pieces of graphic that make up the model that I'm going to show. One point is that I'm mostly off the shelf models and one of my purposes was to exposit this business cycle theory in a way that neoclassicals could understand and maybe even Keynesians, I don't know. But that was what I was trying for. So production possibilities frontier is something you see in chapter one of virtually every principles text on the market loans theory is something you see in most of them and the supply and demand for loans which gives you an equilibrium interest rate. The structure of production is the one unique to the Austrian school. We talked about that yesterday when I did capital theory so I could be brief about that today although it would be included in this presentation. That's the Hayakian view of the sequence of stages of production and stage specific labor markets. Well we know what the labor markets look like is supply and demand for labor and you see that in the Keynesian theory although that market doesn't function very well and you see it in other theories but the unique thing about the Austrians is to understand the business cycle you can't just look at the labor market. You have to look at how that market works at different stages of production because it works differently depending on changes in the interest rate it turns out. Then the application here is simply sustainable growth. We show how the economy can grow without any reversion to trend. In other words it doesn't go bust and on the other hand how unsustainable growth in fact gives you a bust. One is based on saving the other one on credit creation. I show the two principles here. Ludwig von Mises set out this theory near the end of his theory of money and credit in 1912 so it was 100 years old just in a few pages, very few pages that he allocated at the end of that book but it was all there pretty much the theory. Hayek's contribution was to make it pedagogically sound and to embellish on the theme that was set out by Mises and so he did that in the late 20s and 30s did battle with Keynes as we'll see in tomorrow's lecture. This is where most of the stuff comes from as far as the theory goes. I want to add one methodological point which is critical I think to understand the difference between the Austrians and Keynes or the Austrians and most of the other business cycle theories including Milton Friedman's own theories about cyclical movements in the economy. It's a methodological point. I'm paraphrasing Hayek here and I think there was a statement that commands a scent just upon hearing it and what he says is that before we can even ask how things might go wrong we must first explain how they could ever go right right? Sound reasonable to you? I think so but the Austrians are unique in that respect when it comes to business cycle theory. Keynes for instance didn't raise the issue at all about how things could go right because he thought they couldn't. He thought that was a problem. There's nothing in the nature of a market system that would cause things to go right and that's why they always go wrong and then he had particulars about just how it does go wrong but even monetarists or other business cycle theorists don't bother with this methodological nicety. Now what I'll warn you about or to prepare you for is that even though this lecture is about the business cycle most of it will be answering that first question of how things can go right to show how the market works to allocate resources intertemporally and in accordance with people's preferences for consumption now as opposed to later which is to say their preferences in terms of saving as opposed to consuming and then once we get through that and we got that down then the business cycle theory is just a corollary. In other words if that market mechanism is interfered with well things don't go right they go wrong and they go wrong in the particular way that's spelled out by the Austrian theory of the business cycle so again I'm sort of preparing you for what's coming. I start out with familiar production possibilities front here again on page somewhere between page 5 and 10 of every macroeconomic or economics that takes buckets used in micro really predominantly rather than macro. I put up my graphic here consumption on the vertical axis investment on the horizontal axis and recognize that I say under favorable conditions that fully employed economy allocates resources to both uses that is consumption and investment making the most of the trade off now under favorable conditions well I mean the market is allowed to work wage rates change to clear the labor market interest rates change to clear the market for loans prices change to clear the supply and demand for goods and services those are the favorable conditions and if that's so then the economy is going to find itself somewhere on that production possibility front here than it is. Okay I just mentioned here that it's a familiar diagram but you see it in every context except for the macro theory you don't see it in macro theory either by Keynes or by the neoclassicals by the monetarists you just don't see it but what it's used for is to illustrate the concept of scarcity you have to give up one thing to get another or to show something about capital and interest and you'll see that kind of a trade off where you see trade off in terms of military and civilians spending Samuelson's favorite use of it guns and butter one thing has to be traded off for another you see it sometimes in the context of economic growth but rarely does it appear in a macroeconomic piece of analysis here it here it will as you'll see okay one of the things that the trade off emphasizes is sort of a bedrock difference between the Austrian theory and the Keynesian theory here I'm putting consumption and investment on separate axes showing that one's a trade off against the other in Keynes they're added together as just two of the forms of spending he's more interested in just total spending which as you know has three forms and that right C plus I plus G concess consumption plus investment plus government spending just add them all up and call it spending and go on from there okay so we're going to trade one off against the other now before I go further let me mention this about the PPF the PPF even in the standard textbooks takes that frontier to correspond to a quote fully employed economy right fully employed economy so if the economy is suffering from cyclical recession then you're inside the frontier yeah sure but full employment doesn't mean 100% does it it means there's about 100% employment doesn't mean that it means about 95% in other words there's 5% unemployment even in a healthy economy which gives some scope for moving beyond the frontier right because policies can drive the unemployment rate down to 4% or even below and has in recent years right and if the unemployment rate is driven down by some perverse policy we're outside the frontier now only temporarily can't stay there it's unsustainable that's the whole idea but it is possible to move outside the frontier if the frontier is defined as not only I define it but as the textbooks define it as fully employed economy okay we'll see how that comes into play later and here I'm showing that horizontalism there is gross investment by gross I mean it's both making good on depreciation and wear and tear and so on obsolescence and so on and I mentioned that out there typically the investment needed just to replace worn out obsolete capital so on something less than the total and so possibly capital is some magnitude like that this is an economy that has some positive net investment as you see in fact the net investment in this diagram would be that difference between gross investment and the smaller amount needed for capital replacement now positive net investment just means that the economy would be growing in other words next year we'll have more resources more to work with and the frontier itself will shift outwards from year to year precisely because there's net investment going on right so the outward shift of the PPF then represents sustained economic growth because you really have that extra investment that you can beef up the productive capacity of the economy with all right so I say watch the economy grow now we can see it grow should be able to hear it grow but I haven't heard it yet the economy grows okay perfectly sustainable four periods of growth are shown here and you get more consumption more investment because the market is at work allocating resources to one or the other in accordance with people's preferences okay and a little digression here I'm going to virtually skip over the rate of expansion depends on a lot of things capital depreciation changes too and maybe more significantly when people earn more income because of the growing economy their saving preferences can change typically the more wealthy you are the more able and willing you are to save and so saving may increase more than in proportion to income I'm not showing that here in the diagram but that certainly can happen now importantly it says I should probably italicize importantly because just how important it is a change in saving preferences underline it too okay change in saving preferences which promotes a movement along the PPF affects the rate at which the PPF expands so it's possible for people to change their preferences and if they do in the markets of working then the economy will move along the frontier suppose they decide to save more okay that's what that says there they become more thrifty they are more future oriented they reduce their current consumption and save instead what happens watch the economy move along the frontier there it goes okay moves along the frontier and it looks pretty amazing it's a miracle right and that happens only in the Austrian school this is what's amazing it doesn't happen in the monetary school because the monitors lump those two things together consumption and investment it's just called Q output and the Keynesians deny that it can move along the frontier in fact if saving occurs the economy collapses Don Prince was reminding me yesterday that there's a famous diagram in Samuelson's text that showed the economy a diagram with a plumbing diagram if you've seen it a plumbing diagram and at the bottom of the diagram is a drain an arrow sticks out of the drain is labeled saving the saving drains out of the economy and at the top of the diagram is an intake for some exogenous force to pour more money into the system who do you think that is so it's odd to see a theory where we can move along the production possibilities frontier especially when you realize that second P stands for possibilities so if you can't move along the production possibilities frontier it should be called a PIF there's an impossibility frontier you have to stay where you are probably incite it so that's the story there so now the economy grows at a faster rate well of course because the savings has beefed up it's like a turbochar is beefed up the amount of investment and the economy can grow faster see if we can get that going watch the economy grow down there it goes hey we got sound thanks Chad I think that's Chad's sound I think he's doing that himself we'll see ok so increased thriftiness makes a difference you can see well here let's just compare the two diagrams I'll put my old one over there and compare them look at the diagrams themselves and look at the left one the economy growing not so fast but it's growing and the other one you've got the economy first saving like that and then growing faster like so ok that's how the economy works as people choose to save that's really just that's what the PPF is all about and I can get that far just by understanding what the PPF actually means so starting with the four periods here what I'm showing is that the savers actually are consuming more now you've had to cut back at first they're consuming more now than they would have been had they not saved in the first place that's what saving is all about that's why your parents are telling you about saving ok market for loanable funds this is the other another element rate of interest on the vertical axis saving and investment so maybe you can't see it on the horizontal axis and essentially there's an application of supply and demand to the market for loans it's an Alfred Marshall he's Mr. Micro so saving constitutes the supply of loanable funds you save you put your money at interest and that's available for lending and guess what the higher interest rates you can get the more likely you are to save it slopes upward like most savings most supply curves demand reflects a business community's willingness to borrow and undertake investment projects that's the demand that's sloped downward as you would expect that demand for loanable funds is the business demand and it's what Mises refers to as the entrepreneurial component of this market in other words business people want to borrow these monies because they think they know about a project they can undertake and make a greater return than what they have to pay interest alright so straight forwardly supply and demand looks like that alright and it's significant that this market is very broadly conceived it's not just the supply and demand for bank loans it's the supply and demand generally for investable funds in other words any way that savings of the individual income earner is put in the hands of investors through financial markets that constitutes the supply and then the demand for loanable funds and so I label that down there it might be too low for somebody to see but I call it investable resources and both Maynard Keynes and Boombaverak of the Austrian and the Keynesian understood the market in that way that's the way Dennis Robertson intended it by the way it's a macro concept so that's the investable resources alright I think I have a little hat tip to Dennis Robertson here yeah it was Dennis Robertson if you haven't seen him before that's him you'll recognize now here's something to think about this diagram and this diagram alone appears in the general theory it's the only diagram in the general theory and he put it in there at Roy Herrod's suggestion Roy Herrod read the manuscript and he told Keynes he said gee Maynard it looks like you're throwing out the loanable funds theory and Maynard says yeah that's it out and Herrod says I'm not sure exactly how the conversation went but this is and Herrod says well if that's what you're doing you better make that clear to your reader because otherwise they won't believe you and Keynes took the advice so he put the diagram in and threw it out so it appears on page 180 I think I say that in you 180 okay so it's the only diagram that appears okay the Austrians bless their hearts they tend not to use diagrams that means an outlier when Hayek drew the triangle but they argue in terms of loanable funds so if people become more future oriented once again like we said before that means they save more so that savings curve shifts to the right okay watch the saving curve shift right where you think you can do it there it goes okay and when they do it reduces interest rates and it offers up more savings for investors to invest and investors borrow it more so than before because it's cheaper right and they can think of projects that have yielded somewhere between those two horizontal dotted lines that they couldn't undertake before but they can now it's all pretty simple all right let's see where we're going to go from here so we see the interest rate falls and the amount of loanable funds available increases with a given technology saving investment or prerequisite is genuine sustainable growth see that does free up the research think what it means to save you know people go to work and they produce things they get paid for it is called income which they consume the rest they save so whatever they say that means that the that some of their output is available for business community to use right and the business community takes command of that by borrowing the saving from the income earners and buying the resources that are not consumed to increase the productive capacity of the economy all right now those two curves tell the same story just from different perspectives so let's put them both on the screen at once and show that they're linked by that those investable resources like so okay and so the the stories I've been two stories I've told can be told all at once now I say watch the saving induced decrease in the interest rate and the corresponding movements of the PPF what you have to do now is turn your head sideways so you have one eye looking at the top diagram and the other eye looking at the bottom but the same thing happens as before except it is very very coordinated you see how that increased investment then gets depicted also as a movement along the PPF as does the increase saving because increased saving means decreased consumption okay so we got a coherent story it's internally consistent it's very sustainable and that just says the marketers that work for you and for me there notice that you have more investment in less current consumption with current there again should be italicized less current consumption now an interesting thing to ponder is that in Keynesian analysis this was just not possible this just couldn't happen in fact what he argued is that according to Keynes has been dropped down there the reduction in consumer spending would result in excess inventories well it would if you're not spending as much you're not buying things from Walmart or Target or whatever you have excess inventories and then you have a reduced spending by Walmart and getting more inventories but Keynes assumed that's what happens all through the economy okay so if people quit spending then spending triple ripples through the system and all spending goes down and instead of moving along the frontier you move inside the frontier right and that's what he calls you can't on the bottom there Keynes's paradox of threat paradoxically if you save and you come back spending the economy goes into recession well he hasn't got wages interest rates and prices adjusting to the new preferences and therefore he gets a malfunction and you move inside the frontier okay so Keynes would be right if he's talking about the inventories at retail he's talking about late stage operations but it turns out that early stage operations is affected dominantly by that low interest rate interest rate effect dominates long term or early stage investment okay while the cutback and expenditure dominates in the early but that's exactly what you want you want to cut down on production for current consumption and you want to increase long term projects which will have goods ready for consumers when they've saved up to buy something okay in fact in class I like to use instead of just saving I like to use saving up for something people save for fun it's not fun okay they save up for something and SUFS although I don't I don't keep carrying that label they save up for something and it's the entrepreneur's job to figure out what is going to sell in this future market with which people have increased savings that they can spend okay and the best of the entrepreneurs will make the biggest profits and so on it's a story can be told many times in a market economy so to keep track of these changes we have to have that production or that structure of production that's what I talked about yesterday so I won't spend quite so much time on it but except to remind you what it's all about the structure of production and by structure of production one phrase I neglected yesterday I'll introduce now is that capital can be seen as simply the produced means of production which is to say plant and equipment tools and machinery that sort of thing that are arrayed temporally in stages and we show the stages here like we did yesterday like so and we depicted just with photos saying that there's some early stages product development and late stages inventory management and we recognize that goods in process move through the stages of production starting at the early stages emerging at the late stages in a temporal succession we try to show that I've got some sound but not much it was like that I've eliminated the model age you don't need to see that again and together the stages form this hyacinth triangle so I just make a simplify it and make it a hyacinth triangle and now I'm showing that with secular growth like we showed with the PPF the economy can grow but this time I'm showing it with the PPF because that consumption majored as a horizontal distance I'm sorry the vertical distance on the PPF is also the output of the last stage of the hyacinth triangle and so let's watch now the PPF and the structure of production expand together not because there's been an increase in saving but just because there's net investment, there's ongoing net investment and so you get that increase that looks like this same with the PPF before and now the triangle is also expanding at a sustainable rate because we've got net investment when people save more though they send two seemingly again italics seemingly contradictory signals you have a decrease in consumption that dampens demand in the late stages that's the derived demand effect but then reduced interest rate that means it cuts costs namely borrowing costs in the early stages and encourages more of it the reason I say seemingly because the contradiction is true only in a Keynesian framework where you have C plus I plus G which way does I go? you've got two forces one is the derived demand effect pushing down the other is the interest rate effect pushing up which way does it go? you might think it doesn't go anywhere or Keynes sort of looks out the window and sees a great depression going on and says well I try I guess it goes down so derived demand it's as far as Keynes is concerned but in capital based macro they're not really conflicting signals they're coordinating signals because they're working at different spots in that structure of production so once again as for emphasis it's just the same thing what's the structure of production respond to an increase in saving and here you see resources leaving the late stages and going to the early stages it looks like that that's the structure of production that will be more consistent with people's new preferences which involve more saving less consumption and once again we can show this using both of those diagrams and what we see is that they tell the same story increased saving then has an effect it turns out both on the magnitude of the investment aggregate and the temporal pattern of the capital creation so we're going to watch again now watch the economy respond to an increased saving so we get a movement along the front here and you get more investment there's our more investment but look at the Iachin triangle you get differential in terms of investment in the late stages more investment in the early stages but more net investment that's the way it works it's a coordinating operation and not one that internally contradictory now Mises when he discussed this he called it malinvestment when it was in the business cycles we haven't really got to that yet so maybe I'll hold off on that point until we get to the actual business cycle so the structure of production is given more of a future orientation which is consistent with the saving that made the restructuring possible that is people are saving now in order to increase their future spending power and the structure changes accordingly this is market at work for you and for me again now see the economy grows more rapidly as before we're just showing them both together okay now here's something fun to do I don't have time on an axis but I brought in this little supplementary diagram that has consumption on the vertical axis and time on the horizontal axis and if you look at let's say the PPF and their consumptions on the vertical axis and so first it goes down then up watch it down then up if you look at the triangles can you see it can you see the original structure production that's had a little more consumption and then so it goes down again then up watch that okay so let's tell the same story now if we just graph it against time it looks like this it goes down like that then up but at a greater rate because you got more growth right goes more rapidly than before and eventually overtakes where the economy would have been had there been no increase in savings now the way you understand this is the saving implies giving up some consumption in the near future and let's cross hatch that you can see what is given up in the near future because you decided to save you're not spent and you do that because you know that you can gain even more in the more distant future again everything sort of hangs together once you get these graphics going they tell the story almost on their own now stage specific markets I want to pick up the pace just a little bit and here I'm just recognizing that the labor market works differently in different stages I don't have room for five labor markets but I'll put two up there and they are early stage and late stage as you can guess and so there's the early stage there's the late stage and those are really the two I've had up before except before I just had photos of the guy in the development lab and the guy at retail here I've got supply and demand for those sorts of services and the reason we need two actually one for each stage is those labor markets are characterized by differential interest rate sensitivities in other words a change in the interest rate will affect one market one way and the other market the other way so when Keynes talks about the interest rate and the interest rate being I'm sorry the wage rate and the wage rate being stuck and all that he's missing the boat this is one of Hayek's point that no no it's not the wage rates the pattern of wage rates the pattern needs to change relative prices need to change and so we can see how they need to change an increase in saving has differential effects on the demand for labor in the early and late stages lower demand for labor in the early stages or late stages higher demand in the early stages let's watch that okay watch the economy respond to an increase in saving again you know what the triangle is going to do so watch the labor markets and you see the demand decrease in the late stages because Target doesn't need as many stock people and it increases in the early stages goes more investments long-term investments are being undertaken because of the low interest rate all right and once I got this far with the diagrams I realized that there's a wage rate gradient there that Hayek mentions in prices and production is a diagram in a footnote of the second edition of prices in production and you can see it there I'm just noticing that wage rate is higher in the early stages lower in the late stages that's what caused labor to move out of early in the low stages all right and that's what Hayek calls the wage rate gradient that remains that maintains that upward trend until the economy has fully adjusted to this new level of saving and then the wage rates will equalize again after the so much labor has moved okay all right well there's all of the different graphics loanable funds market production possibilities frontier structure production stage specific labor markets we see how they're all tied together now we'll see them all at once for the first time it looks like that and now we can see all at once what happens when people decide to save more you can look around the diagrams and know exactly how things are going to work and they're going to work in a coordinated way I'll pull the trigger I'll do it twice here's the first one okay watch okay savings increases moving along the frontier reshaping the structure production wage rate gradient I'm going to do it again okay that's the way it works now now we've got to the end of the first part of the lecture in other words I've shown you how things can work right if markets are allowed to work and now it's just a corollary to show that a business cycle occurs when markets are interfered with by policy namely in artificially lowering interest rates and I start I'm trying to give myself some credibility here and I've never been able to look that stern I've tried but that's as stern as it gets okay and this is Steve Hankey at Johns Hopkins and look what he says he says with interest rates artificially low he's not talking about increase in savings talking about Federal Reserve or interest rates consumers reduce saving yeah because they're not getting as much interest and they haven't shifted the supply curve they're just not getting as much interest they reduce saving in favor of consumption and entrepreneurs increase the rate of investment spending so that now we've got discord nation already and then you have an imbalance between saving and investment on an unsustainable growth path this in a nutshell is a lesson of the Austrian critique of central banking developed in the 1920s and 30s and notice he wrote this in May of 2008 published it in forums nobody read it I think but that's what he did alright this is Hayek and I put this in here because some critics of Hayek said oh well Hayek changed his mind in his later years well he didn't really because this is a quote from 78 which might have been one of the last things he had to say about business cycle theory it comes from an interview so it's transcription of something delivered orally but it's not quite as smooth writing as you would expect but let's read through he says booms have always appeared with a great increase in investment a large part of which proved to be erroneous mistaken yeah because nobody was saving more that of course suggests a supply of capital that was made apparent which wasn't actually existing in other words the market signal said there's more resources available to invest there really wasn't there were less because people were consuming more with those low interest rates okay so the whole combination of a stimulus to invest on a large scale followed by a period of acute scarcity of capital when it comes to light that we can't finish all these projects has been misdirectioned due to monetary influences he says in that general schema I still believe is correct and that was in 78 so he didn't change his mind now we get to the credit expansion which I only have 15 met but that's all I need okay I'm not worried not worried we got credit expansion so now instead of saving you have an increase in the money supply and of course money comes through credit markers new money comes through credit markers so it shifts the supply of credit without increasing saving in fact it decreases saving as we'll see and this is here it says money masquerades a saving it was the supply of normal funds shifts to the ride but without there being any increase in saving watch the opposing movements of saving and investment as a central bank adds to the money supply that will be delta M okay now I just want you to get it that this is a totally totally different sort of story because it involves a central banker a policy maker okay and he's there thinking that interest rates ought to be lower for some reason or other probably because he's trying to help Bill Clinton okay and so he increases the supply of credit that's S plus delta M it's not S prime and now you can see the new equilibrium it's not really an equilibrium it's a double you've got investors wanting to invest more while savers are saving less and they're saving less because the old supply curve the old savings curve is still applicable and at lower interest rates they don't want to save as much might as well spend I mean you can feel that right now in this economy if interest rates are 0.07 or whatever it is you just soon you just soon spend okay okay responding to lower interest rate people actually save more and they consume results not a sustainable equilibrium but rather a disequilibrium that for a time is the infusion of loanable funds now here's where in time and money I show what would happen if Congress instead of instead of Greenspan will have Congress passes a law a uniform across the board economy wide ceiling on interest rates okay and that would be that would be illustrated by that lower horizontal line interest rates lower than now if they did that and if they could enforce it it would be very difficult to enforce it if they did that and could enforce it then of course it would immediately generate a huge credit crunch a huge credit shortage and the economy would drop like a rock right then okay if you credit markets that boldly then the economy is going to go down and go down fast okay boy we wouldn't want that how about just papering over that shortage with money created for the purpose you see the only difference between the credit control and the credit expansion is the time element in other words with monetary expansion it's like a it's like a credit control it's like papering over the shortage with new money created for the purpose okay in which case you don't get an immediate downturn you get instead of boom but it just means later on you'll get a big downturn and I show here I probably lectures a little head of my graphics but here I've shown that investors are moving down along curves and savers are moving down along their savings curve and then the difference is precisely the delta M that's the horizontal difference between the shifted curve and the unshifted curve so that delta M is the papering over of what otherwise would just be credit control right so in time and money I show that a credit control will foilery market immediately and the expansion will ignite a boom which eventually will lead to a bust here is just saying that much of high-ex monetary writings direct attention away from the quantity theory conclusion that increasing the money supply causes prices to increase yeah it does we all know that but his attention was to the distortion of credit market and how that affects the economy as can be shown by that lovable funds market now look what happens upstairs here you have to trace up from both hollow points there the consumers are I'm sorry the investors are trying to invest more because they've got cheap credit okay but the consumers are trying to consume more they don't want to say because interest rates are so low okay and what we see is that consumers are trying to push up investors are trying to push to the right and the resultant of that of those vectors are pushing beyond the PPF to some I call it a virtual equilibrium okay where you're not you're not going to achieve it but it's outside the PPF you can lunge towards it but you're going to be thrown back with the bust okay so that's the story there now let's look at it in terms of the PPF again now you have conflicting signals right you've got the low interest rate is actually causing long-term projects to be initiated not that they can be completed they can't they're initiated and so they upper tiers of that those production processes are dotted lines but some resources are allocated towards consumption because there's an increased demand for consumer goods and those resources have to be have to come from somewhere in that production process that sort of got the middle of it or something Richard Strigel whose name you might not be totally familiar with has a book out or had a book out clear back at that time anybody remember the name of that book is something about capital in production thank you and in capital in production he actually he actually explained it this way and said that the triangle is essentially pulled both ends are pulled against the middle and in one sense I was glad to find that that reference another since I wasn't because that's what my diagrams had said already and I thought this doesn't seem to be quite consistent with Hayek or Mises and yet it's in Strigel so I thought I was original in that sense but I wasn't it was it's what they call unnecessary originality it was already in Strigel and it's in Maklop so it works that way alright so the dynamics of boom and bust entail both over investment and mal investment Mises emphasized the mal investment almost to the point of saying there is no over investment and the illustration he used to show no over investment was rigged was set up to do just that in other words he used scope for over investment in his stories but clearly what we can see you have over investment stretching beyond the PPF but you also have mal investment and you have over consumption in both diagrams I could have called that mal consumption but that sounds like mal nutrition or something so called mal consumption and if you check on Mises you'll find that he uses the phrase probably have it down here Mises repeatedly uses the phrase mal investment and over consumption over consumption because you're not getting enough interest for your money mal investment because you're responding with too long term capital with that low interest rate so the tug of war that pips consumers against investors pushes the economy beyond the PPF the low interest rate favors investment and increasingly binding resource constraints keep the economy from reaching the extra PPF point in other words resources aren't investment resources just aren't made available and that comes to light eventually in some form or another so if you look at the PPF you can see it starts moving beyond the PPF with an investment bias because of that low interest rate and then when it runs up against resource constraints a lot of investors realize that they can't finish their projects profitably in fact I owe to Friedman the terminology for that he calls it now let me think what he called it he calls it desperation borrowing this is business people which they hadn't started the project but now that they've gotten into it they're trying to cut their losses by borrowing even at high prices in order to finish their investment process but they can't all borrow enough money to buy enough resources because there aren't the resources there and so eventually the economy turns south and guess what keeps going there is what Hayek calls and he called this before Keynes ever wrote the general theory a secondary deflation the whole economy is in disequilibrium because of this out of whack interest rate it goes into recession and that can easily feed on itself and it can spiral down into a deep depression that's not to say that Hayek has turned Keynes in no no this is just what can happen in the aftermath of the downturn which was caused by the credit expansion what we can see is that when Keynes looked at the situation all he saw was that long downward moving spiral that's all he saw he says that's what has to be explained and he explained it in terms of a collapse in animal spirits loss of confidence and there was a loss of confidence but not just an irrational loss of confidence it was a loss of confidence because the whole economy was discoordinated which had been revealed by people trying to finish projects that they wish they hadn't started okay now here is the language of disequilibrium you've got wedge between saving and investment you've got tug of war between consumers and investors you've got dueling triangles out of that terminology to John Cochran at Metropolitan State in Colorado and again you've got the connected diagrams I haven't shown the labor diagrams because I need more than two here and don't have room for them to get too messy okay looks like that now this is a summary diagram and I'm going to apologize for putting out three P's here it makes it more sound like a management lecture or worse but I'll succumb to it padding the supply of loanable funds with new money drives a wedge between saving investment papering over the difference between saving and investment gives play to a tug of war between consumers and investors pitting early stage against late stages distorts a hike in triangle in both directions the temporal discoordination eventually turning boom into bust that's the Austrian theory of the business cycle watch the economy respond to credit expansion we'll get all the ones here you didn't know that's what then happened now how many can remember who this figure is that's Joe the plumber, in other words he's just the innocent guy out there trying to make a living can't your guys get it straight you got just a couple of voices in the wilderness to say that the Austrians aren't totally neglected from the economists and this is clear back in 2002 when we were talking about dot com instead of the housing bubble recognition of the Austrian business cycle theory is applied to the dot com boom and bust comes from September 28 and here's what they said the recent business cycles in both America and Japan display many Austrian features as indeed they did he's almost an honorary Austrian he has a Swedish name I know so writing in 2008 here's what he says operating an interest targeting regime in other words manipulating interest rates and keeping them low keying on the CPI the Fed was lured into keeping rates far too low for too long the result was inflation of asset prices that's in the early stages isn't it combined with a general deterioration of credit quality of the desperation borrowing going on this of course does not make a Keynesian story it is rather a variation on the Austrian investment theme you should have said mal investment over investment but so he recognizes that way and the variation had to do with the risk that was involved and that's explained by you know Fannie Mae, Freddie Mac and Barney Frank let's see one more maybe I don't know this guy anybody know this guy Forsythe I showed up on Fox voices and here he is but the Austrian were the ones who could see the seeds of collapse in the successive credit booms is aided and abetted by the Fed policies especially under former chairman Alan Greenspan while he disables again the responsibility for boom and bust most recently gives the day and so on monetary policy played a key role in creating the successive bubbles and busts during his tenure from 2006 and that's the story okay thank you much right applause