Date: Fri, 10 Jan 1997 17:27:48 -0800 From: jmlib (jmlib) Subject: business cycles Would business cycles exist in a completely self-regulating market economy? Critics of free markets say yes, and claim that govt smoothes out these natural wrinkles (and that, of course, this is one reason why govt intervention is needed, they say). I seem to recall seeing a chart showing wild ups and downs in the economy before the establishment of the federal reserve system, and thereafter somewhat longer and pronounced cycles. I've read that business cycles nowadays are in fact pretty much caused by govt actions, and that they should disappear when we return to an economy freed of govt interference. On a general-semantics mailing list, one of the participants offered a popular explanation of business cycles: ------------------------------------------------------------------------ In the beginning, persons have been working for a while and start to feel secure in their jobs. They feel safe and expansive, and go out to borrow and spend. As they demand more goods, manufacturers not only make more to meet increased demand. Vendors find they need larger inventories, and to increase them, order more than the increase in demand. Making more goods puts more persons to work, increases payrolls, demand for goods, etc. and for a while, everything goes up, up, up. In time, persons have what they want most, buy less, start to pay down their credit cards, pay for what they bought. Oops! Not only do they buy less, but vendors find they have more inventory than they need. They stop buying from the manufacturer and sell from inventory. So, the factory now gets not less orders, but NO orders, and lays off workers. The layoff not only reduces payrolls and demand, but makes the workers feel insecure, spend less. Everything goes down, down, down. Every step, persons act rationally. But, each influences the others, and collectively they do what none intended. Some persons speak worshipfully of Adam Smith's "invisible hand" that guides greedy persons to serve the common good, but I've never heard anyone speak of the dysfunctional invisible hand in economic cycles. ------------------------------------------------------------------------ I responded that he completely neglected the influence of the govt (but I'm not quite sure of the mechanisms of this influence: setting interest rates, expanding and shrinking the money supply, etc.), said that it seemed rather unlikely that everybody would be doing this all at the same time, and mentioned that "greedy" people can operate in govt too, causing the rest of us to be at the effect of their decisions. However, he offered a clear, easily grasped (though perhaps wrong) explanation, and I wasn't able to come up with an equally appealing free-market explanation. So, what sticks in people's minds is the false explanation. I fully realize my personal limitation in this, and would greatly appreciate a clear, easily grasped, appealing free-market explanation of business cycles, the role of govt in them, and the natural operation of a fully free market in terms of "cycles", "employment rate", etc. A nutshell explanation would be wonderful, and probably useful to all professors who eventually will be asked this question. -- John McPherson (jmlib@lumina.ucsd.edu) * Host, Professors of Liberty Email Network (to post, send email to "libprofs@lumina.ucsd.edu" for admin functions, to "libprofs-request@lumina.ucsd.edu") * ftp://lumina.ucsd.edu/pub/.../libuniv_dir/libprofs.html =========================================================================== Date: Fri, 10 Jan 1997 19:01:04 -0800 (PST) From: Fred Foldvary On Fri, 10 Jan 1997, John McPherson wrote: > Would business cycles exist in a completely self-regulating market > economy? Critics of free markets say yes, Some economists who think markets work well also believe cycles or at least fluctuations would exist in a pure free market, though less severe or frequent due to not having politically-imposed distortions and disturbances. My analysis is that there is no inherent reason for cycles, although there will always be minor noise fluctuations and periods of greater and lesser investment. But there would not be any downturns or depressions. The reason is that when barriers to enterprise are removed, labor becomes fully employed, the monetary system flexibly adjusts to money demand, and real-estate speculative booms are eliminated (due to the absence of public works subsidies that induce speculative malinvestments fueled by easy credit). This synthesizes real and financial cycle theories, as the real world has both. Without artificial booms, there are no subsequent busts. In my analysis, the key causes of major cycles are the control and manipulation of money and banking, and the tax system that subsidizes real estate by taxing labor and enterprise to finance public works. In this geo-Austrian synthesis, money injections lead to excessive credit, fueling malinvestments, the worst of which are in land speculation and excessive real-estate construction. When costs (interest rates, wages, land and rent, taxes) rise, investment slows. This leads to the downturn. Real-estate prices collapse (witness 1989-92), and banks, heavily invested in real estate that is now worth less than its loans, collapse with it. This happened in 1930-33, as well as the recent Savings & Loan fiasco. This scenario has repeated about every 20 years since the 1830s. The 1920s were a classic example of a real-estate boom followed by a crash that brought the banks down. > and claim that govt smoothes > out these natural wrinkles (and that, of course, this is one reason why > govt intervention is needed, they say). Government does do some smoothing, but the recovery and boom are smoothed down as well - witness the FED pushing up interest rates whenever the economy grows "too fast". The paradoxical decline in stocks and bonds whenever the economy shows signs of a boom is not because Wall Street hates prosperity but because the FED thinks it leads to inflation, whereas in fact its own excessive money creation is the inflation. Smoothing is an intervention to deal with the original destabilizing interventions. But sometimes the government does not smooth but boosts the recovery to an artificial boom, as in the early 1980s and 1968-72. > I seem to recall seeing a chart > showing wild ups and downs in the economy before the establishment of > the federal reserve system, and thereafter somewhat longer and pronounced > cycles. I read that the 1870s and 1890s depressions were not that short. The 1974 recession was rather severe, and the 1989-92 trough was rough in California, New England, and other regions; it may have kept Bush from winning the election. Anyway, the US prior to the FED did not have a free-market money and banking system; the money was already nationalized during the Civil War. > I've read that business cycles nowadays are in fact pretty much > caused by govt actions, and that they should disappear when we return to > an economy freed of govt interference. There is a hypothesis about a political business cycle, if that's what you read. But fiscal and monetary policy also lead to cycles. > In time, persons have what they want most, buy less, start to pay down > their credit cards, pay for what they bought. Oops! Not only do they buy > less, but vendors find they have more inventory than they need. Ugh! This is that old general glut fallacy. A fundamental premise of economics is that people never have all they want. Human desires are unlimited. Suppose most folks are fully extended in credit and so their consumption stops growing or even declines. Their income does not disappear - it gets transfered to lenders or it goes into savings. They then consume or invest. With full employment, if there is less consumption, then there is more investment. The interest rate will adjust investment to savings. All vendors together cannot have excess inventory unless something else makes both consumers and investors stop buying. Vendors in particular industries can have surpluses for a time, but since desires are unlimited, the generation of income creates the effective demand for products. > Some persons speak worshipfully > of Adam Smith's "invisible hand" that guides greedy persons to serve the > common good Note the loaded propaganda - greedy persons. >, but I've never heard anyone speak of the dysfunctional > invisible hand in economic cycles. This writer has never read Marxists and Keynesians? =========================================================================== Date: Fri, 10 Jan 1997 23:34:01 -0800 From: jmlib (jmlib) The fellow whose post I forwarded has responded to my comments: --------------------------------------------------------------------------- I did not intend to write _all_about_ economic cycles. Certainly the Fed plays a role, and different persons act differently. I intended a thumbnail sketch of a time-lag stimulus-response which led to unintended consequences, as a parallel to drivers who tail-gate and crash, but on a different scale. [John M.: It should be a simple matter to adopt his format, but with the proper major cause of economic cycles.] FWIW, I studied cycles under a Nobel prize winning member of the Austrian School of economics (not one you named). He was perhaps the worst _teacher_ I can recall, though a pleasant man. He asked the class if anyone could name a member of the Austrian School. One could, but did not name him. I had one of my best ideas ever for a paper in that class, but lacked the math to research it, much less write it. He passed me anyway. My subject was "How computer programs managing inventory influence economic cycles." [John M.: Let me guess ... "before the inevitable cycle bust when inventories would otherwise pile up unwanted, businesses can use sophisticated inventory computer programs to anticipate possible gluts and pre-emptively reduce factory orders gently, and in turn the factories may not need to lay off (as many) workers ... so the overall effect is to help smooth out the cycle downturns." ? :-)] --------------------------------------------------------------------------- Re: Fred Foldvary's response to the first forward: >, but I've never heard anyone speak of the dysfunctional > invisible hand in economic cycles. This writer has never read Marxists and Keynesians? My guess is that he has and that the "anyone" he's speaking about here are those nefarious "worshippers" of Adam Smith. The main point in my response to him was that explanations such as the one he offered conveniently leave out the invisible hand of government in causing economic dysfunction. > In time, persons have what they want most, buy less, start to pay down > their credit cards, pay for what they bought. Oops! Not only do they buy > less, but vendors find they have more inventory than they need. Ugh! This is that old general glut fallacy. A fundamental premise of economics is that people never have all they want. Human desires are unlimited. Hmmm. It certainly is my experience that I don't have all I want. I wonder if modern-liberals honestly don't want more than they have. Peter Breggin said something to the effect that modern- liberals tend to be more concerned about what _others_ (especially "the under-privileged") have, and want them to have what they themselves have ... and they apparently assume this is all they _should_ have :-). General-semantics enthusiasts in particular tend to lean towards the empirical, so I imagine Nelson will challenge me (and the whole of economics) on the premise of infinite human desires. In fact, in the g.s. literature, a major author refers to "IFD disease": Idealism (unrealistic expectations or perhaps "unlimited human desires") leads to Frustration, which in turn leads to Demoralization and Depression, which tends not to be good for people ... and the proposed cure is to consciously adjust our desires and expectations to be realistic (and limited). So, a modern-liberal general-semanticist may be doubly hard to convince on this point! It may be easier to point out that: "the key causes of major cycles are the control and manipulation of money and banking, and the tax system that subsidizes real estate by taxing labor and enterprise to finance public works. In this geo-Austrian synthesis, money injections lead to excessive credit, fueling malinvestments, the worst of which are in land speculation and excessive real-estate construction. When costs (interest rates, wages, land and rent, taxes) rise, investment slows. This leads to the downturn. Real-estate prices collapse (witness 1989-92), and banks, heavily invested in real estate that is now worth less than its loans, collapse with it. This happened in 1930-33, as well as the recent Savings & Loan fiasco. This scenario has repeated about every 20 years since the 1830s. The 1920s were a classic example of a real-estate boom followed by a crash that brought the banks down." Thanks for this neat capsule explanation with supporting evidence. Also, this: "Suppose most folks are fully extended in credit and so their consumption stops growing or even declines. Their income does not disappear - it gets transfered to lenders or it goes into savings. They then consume or invest. With full employment, if there is less consumption, then there is more investment. The interest rate will adjust investment to savings. All vendors together cannot have excess inventory unless something else makes both consumers and investors stop buying. Vendors in particular industries can have surpluses for a time, but since desires are unlimited, the generation of income creates the effective demand for products." ... neatly refutes the popular explanation. I read that the 1870s and 1890s depressions were not that short. [...] the US prior to the FED did not have a free-market money and banking system; the money was already nationalized during the Civil War. What do you think were the specific mechanisms causing these extended depressions before the advent of the Fed? Also, are there comparable records of general economic conditions before the nationalization of our money, and if so, what do they show? I suppose it would be ideal if we could point to a nearly completely free market and show that general conditions gradually improved with some transient fluctuations ... -- John McPherson (jmlib@lumina.ucsd.edu) * Host, Professors of Liberty Email Network (to post, send email to "libprofs@lumina.ucsd.edu" for admin functions, to "libprofs-request@lumina.ucsd.edu") * ftp://lumina.ucsd.edu/pub/.../libuniv_dir/libprofs.html =========================================================================== Date: Sat, 11 Jan 1997 11:02:52 -0600 From: King Banaian Subject: Re: business cycles (and forest fires) jmlib wrote: > > Would business cycles exist in a completely self-regulating market economy? I think the consensus of new classical economists would be yes. Most of them have moved off the monetary misperceptions models (wherein a central bank can induce cycles by rather pernicious behaviors) to real business cycles, where cyclical behavior is induced by technology shocks. The theory still has a problem confronting some stylized facts -- it cannot explain labor productivity behavior over the cycle, for one, despite several attempts by proponents to find otherwise -- but it is a model that has many adherents. I recall a few years ago that a proponent of this theory presented a paper on cycles in which he gave a detailed description of the "time-to-build" problem (the fact that the decision to invest and the onset of new production from that investment occurs with a lag) including a twist about replacement investment (replacing depreciated capital). He argued in part that cycles would occur because the replacement capital had different technology than the depreciated capital. I remarked that the story was highly Hayekian. He was put off by that, saying Hayek never wrote out the math. I chalked that up to ego. Unfortunately, that paper never made it to print. > I seem to recall seeing a chart > showing wild ups and downs in the economy before the establishment of > the federal reserve system, and thereafter somewhat longer and pronounced > cycles. True enough. Cycles in the 1800s around the world were shorter and sharper. The recessions were particularly nasty in the second half of the century (1873, 1893 come to mind.) These cycles occupied the minds of writers like Wicksell, Hawtrey, and Fisher. > I've read that business cycles nowadays are in fact pretty much > caused by govt actions, and that they should disappear when we return to > an economy freed of govt interference. It seems to me, however, that a libertarian explanation of these cycles has to rely in some part on the writings of Schumpeter and the process of creative destruction. Schumpeter was one who argued repeatedly, and I think with more force than Mises or Hayek, that recessions were not only inevitable, but a good healing process for the economy. I explain this to students by invoking the debate over whether we should at all times extinguish forest fires, or whether a naturally caused fire (by lightning strike) should be viewed as a curative for overgrowth. Recessions do not hit all industries equally -- those in less productive sectors are hastened towards decline in a downturn. This frees capital to other, more productive sectors. Having these induced by a productivity slowdown or some negative supply shock is like having a lightning strike in the forest. > > On a general-semantics mailing list, one of the participants offered > a popular explanation of business cycles: > [snipped to save space] I read that to be an underconsumption theorist explanation. This theory flies in the face of another stylized fact: Interest rates tend to be high and rising as we enter a recession. If there was a glut of savings, interest rates would be falling. Underconsumption theorists are a rather rare breed these days. The more detailed comments by Fred Foldvary underscore that point. Governments smooth cycles for a variety of reasons. I wrote my dissertation on political business cycles ten years ago. At that time we thought governments manipulated employment just for the sake of re-election. But that story doesn't work either: Political parties are not that short-sighted (such manipulation can easily lead to your party being unable to win the next election), and parties are partisan and are much more likely to manipulate policy for their own interest groups -- reducing unemployment is too vague a policy to help Indonesian contributors to presidential campaigns! For the most part, the rational expectations revolution in macro has lead us to believe systematic manipulation of the economy for electoral advantage is mearly impossible. But more to the point, just as the Forest Service is catching on to the healing nature of forest fires, macroeconomic policy needs to come to the view that we heal our economy from time to time by pruning away declining industries. Those industries will clamor for countercyclical policies to protect themselves, and we should argue against this. King Banaian Dept. of Economics St. Cloud State University St. Cloud, MN 56301 =========================================================================== Date: Sat, 11 Jan 1997 17:31:08 -0800 (PST) From: Fred Foldvary On Fri, 10 Jan 1997, jmlib wrote: > What do you think were the specific mechanisms causing these > extended depressions before the advent of the Fed? Also, are > there comparable records of general economic conditions before > the nationalization of our money, and if so, what do they show? > I suppose it would be ideal if we could point to a nearly > completely free market and show that general conditions gradually > improved with some transient fluctuations ... > We can go back to the 1830s as an example. Banks were controlled by the state governments and often prohibited branch banking and required banks to buy state bonds. Canal building projects led to land speculation funded by these banks. Land prices for speculative purchases became so high in Chicago, for example, that purchases for actual use stopped. The subsequent collapse of land prices brought down many banks and contributed to the panic of 1837. Land prices recoverred and there was another boom, leading to the depression of the 1850s. In the 1860s and early 1870s, there was a post-Civil War boom fueled this time by railroad building, with much land speculation especially in San Francisco. Instead of prosperity, the railroad speculation led to a crash and the depression of the 1870s. The next depression was during the 1890s, which was quite severe. There was then the panic of 1907 and a brief depression following World War I. In each case, real-estate construction and land speculation fueled by bank lending was a prime contributor, and the same phenomenon (interrupted by World War II, but started up again in the late 1960s) led to depressions in 1974, 1982, and 1990. All kinds of other factors contributed, including the oil price shocks, tax law changes, and various banking policy changes, but running throughout the history of the major business cyles (there are also minor ones with other causes) is real estate booms fueled by easy credit, which seems to be the basic cause. See Homer Hoyt, One Hundred Years of Land Value in Chicago, as a key referece. Also Fred Harrison, The Power in the Land. Austrian economists emphasize the financial/banking side in the Austrian theory of the business cycle, usually mentioning unspecified malinvestments. The real-estate aspect is complementary, and fills in many of the details. By the way, the premise that human desires are unlimited is not confined to self-centered desires but also includes desires for one's family and community, which welfare-state liberals might relate to a bit more. Fred Foldvary =========================================================================== Date: Sat, 11 Jan 1997 17:44:32 -0800 (PST) From: Fred Foldvary On Sat, 11 Jan 1997, King Banaian wrote: > Schumpeter was one who argued repeatedly, and > I think with more force than Mises or Hayek, that recessions were not > only inevitable, but a good healing process for the economy. It is not evident to me why the economy should require "healing." Individual firms and even industries can get sick and decay, sure. But why with a pure market economy would an entire economy be sick? Forest fires burn down one forest area, not a whole continent. Consider buildings: here and there, a building will become obsolete and need to be town down; but does an entire city have to be demolished? Medically, individuals can get sick and an epidemic might come around, but I don't know of any doctors who says this sickness is a good thing. > just as the > Forest Service is catching on to the healing nature of forest fires, > macroeconomic policy needs to come to the view that we heal our economy > from time to time by pruning away declining industries. Certain industries and sectors of the economy can get healed that way, but that does not imply a general economic downturn and depression. Fred Foldvary =========================================================================== Date: Sun, 12 Jan 1997 01:06:12 -0600 From: King Banaian Fred Foldvary wrote: > > On Sat, 11 Jan 1997, King Banaian wrote: > > > Schumpeter was one who argued repeatedly, and > > I think with more force than Mises or Hayek, that recessions were not > > only inevitable, but a good healing process for the economy. > > It is not evident to me why the economy should require "healing." > Individual firms and even industries can get sick and decay, sure. > But why with a pure market economy would an entire economy be sick? > Forest fires burn down one forest area, not a whole continent. > Consider buildings: here and there, a building will become obsolete > and need to be town down; but does an entire city have to be demolished? An economy is no more than the sum of a series of market endeavors. A set of these become sick, and you have a recession. If you look at diffusion indices of industrial production, it is seldom that even 80% of industries have declining production at any time. Just as the forest fire burns one area, recessions burn out some industries while others grow. We scarcely noticed the 1990 recession here in the Midwest, but felt the 1981-82 recession acutely. It was the opposite on the coasts. > > just as the > > Forest Service is catching on to the healing nature of forest fires, > > macroeconomic policy needs to come to the view that we heal our economy > > from time to time by pruning away declining industries. > > Certain industries and sectors of the economy can get healed that way, but > that does not imply a general economic downturn and depression. But it does, as I mention above. Take a look at the diffusion indices in the Survey of Current Business from the Commerce Department. --kb =========================================================================== Date: Sun, 12 Jan 1997 11:18:50 -0800 (PST) From: Fred Foldvary On Sun, 12 Jan 1997, King Banaian wrote: > Fred Foldvary wrote: > > > > On Sat, 11 Jan 1997, King Banaian wrote: > > > > > Schumpeter was one who argued repeatedly, and > > > I think with more force than Mises or Hayek, that recessions were not > > > only inevitable, but a good healing process for the economy. > > > > It is not evident to me why the economy should require "healing." > > Individual firms and even industries can get sick and decay, sure. > > But why with a pure market economy would an entire economy be sick? > But it does, as I mention above. Take a look at the diffusion indices > in the Survey of Current Business from the Commerce Department. The context of my statements above and previously in this thread was regarding the necessity of depressions or cycles in a pure market economy. Hence data from our mixed, interventionist economy are irrelevant. Fred Foldvary =========================================================================== Date: Mon, 13 Jan 1997 10:15:14 -0600 (CST) From: "George Selgin" To: libprofs Cc: Lwhite@rigel.econ.uga.edu Two points concerning pre- and post-Fed business cycles: (1) although it was once generally believed that real economic activity was more volatile after the Fed (always excepting the Great Depression--a big exception, that!), more recent research by Cristina Romer casts doubt on this impression, arguing that increased volatility is a statistical artifact, due to the poor quality of pre-Fed statistics; (2) suppose real variables really were more volatile before 1914. That doesn't prove that the government smooths business cycles, unless one assumes that the government did not intervene at all in markets before the founding of the Fed. As a matter of fact, the pre-Fed banking system was highly unstable, not because it was unregulated, but because of perverse regulatory restrictions that made the money stock quite "inelastic", generating routine, seasonal and cyclical shortages and surpluses of money. On this see, for example, my and Larry White's paper in the 1994 *Business History Review* on "Monetary Reform and the Redemption of National Bank Notes." On the other hand, there is reason to expect less dramatic cyclical fluctuations under fiat money than under a gold standard, because overexpansion tends to have a boomerang effect in the latter set-up, whereas it might merely result in permanent inflation in the former. That's not necessarily an arghhument against gold: secular inflation is not desirable, after all. Thje question is whether one can have a gold-standard, and therefore avoid secular inflation, without business cycles. I think the answer is that one can avoid serious cycles under a old standard, provided one doesn't have destabilizing bank regulations, including monopoly note issuance. George Selgin =========================================================================== Date: Mon, 13 Jan 1997 10:48:10 -0400 (EDT) From: Bill Woolsey >In the beginning, persons have been working for a while and start to feel >secure in their jobs. They feel safe and expansive, and go out to borrow >and spend. As they demand more goods, manufacturers not only make more to >meet increased demand. Vendors find they need larger inventories, and to >increase them, order more than the increase in demand. Making more goods >puts more persons to work, increases payrolls, demand for goods, etc. and >for a while, everything goes up, up, up. The problem with this story is that it doesn't account for the relationship between aggregate demand and money supply/ demand. While this story is adequate for an individual or even entire sectors of the economy, the only way total spending can rise is if there is either an increase in the supply of money or else an increase in velocity (how often each dollar is spent.) By simple algebra, velocity is inversely proportional to the amount of money held at a point in time relative to income. While this optimism story might be true, I would insist that its advocate explain how either the money supply expands or else why people are choosing to hold less money relative to their incomes. More importantly, I would like to see included about how the "down, down, down" phase involves either a decreae in the money supply or else an increase in the amount of money people are choosing to hold. I could easily make up a plausible story, but that is what is missing. Why is it important to include such a story? Well, it directly points to monetary institutions. Perhaps there are monetary institutions that will not expand the supply of money in response to greater optimism and even contract the money supply if people should choose to hold less money due to their greater optimism. In the opposite situation, there may be monetary institutions that do not contract the money supply when optimism disappears and even increase the money supply if people choose to hold more money due to pessimism. Since the quantity of money is controllable by the monetary authority today, the failure of that authority to make proper changes in that money supply is the fundamental explanation as to why something like changing optimism might cause changes in total spending. Federal Reserve failure One can then consider whether this is due to incompetence or due to the difficulty of the task. Things were somewhat different in the pre-Federal Reserve U.S. I wouldn't describe that as a free market monetary system. Still, I can imagine many possible systems that I would call free market systems. I think all would be subject to recessions. The question is how often and how deep. And which would perform better. And how the best would do relative to the Federal Reserve. Bill Woolsey Email: Bill.Woolsey@Citadel.edu Dept. of Business Administration Home: (803) 795-5062 The Citadel Office: (803) 953-5161 Charleston, South Carolina 29409 Fax: (803) 953-7084 U.S.A. =========================================================================== Date: Mon, 13 Jan 1997 11:40:25 -0400 (EDT) From: Bill Woolsey >FWIW, I studied cycles under a Nobel prize winning member of the Austrian >School of economics (not one you named). He was perhaps the worst >_teacher_ I can recall, though a pleasant man. He asked the class if >anyone could name a member of the Austrian School. One could, but did not >name him. I thought there was only one Nobel-prize winning member of the Austrian School--Hayek. Who was the bad teacher under which he studied? =========================================================================== Date: Mon, 13 Jan 1997 12:47:59 -0600 (CST) From: "George Selgin" Bill Woolsey is right. I meant to say that conventional statistics show real activity to have become *less* volatile after the Fed. George Selgin ------------------------------ From: Bill Woolsey Mon, 13 Jan 1997 11:31:26 -0400 (EDT) To: George Selgin Subject: Re: Fw: business cycles >Two points concerning pre- and post-Fed business cycles: (1) although it was >once generally believed that real economic activity was more volatile after >the Fed Less volitile after the Fed, right. You might want to send a correction to the list, though maybe everyone else caught it as a typo as well. >quite "inelastic", generating routine, seasonal and cyclical shortages and >surpluses of money. On this see, for example, my and Larry White's paper in the 1994 *Business >History Review* on "Monetary Reform and the Redemption of National Bank >Notes." What about Timberlake's notion that the treasury was doing open market operations with gold during the period? I don't see this as a reply to your claim, just another subject. While I'm at it, what about those treasury bills during the early 19th century? Government took them at par for taxes and those supplying goverment had to take them at par. Timberlake says they were used as bank reserves, were an expansion of the monetary base, and were responsible for economic fluctuations. Interesting. Bill Woolsey Email: Bill.Woolsey@Citadel.edu Dept. of Business Administration Home: (803) 795-5062 The Citadel Office: (803) 953-5161 Charleston, South Carolina 29409 Fax: (803) 953-7084 U.S.A. =========================================================================== Date: Mon, 13 Jan 1997 11:44:29 -0400 (EDT) From: Bill Woolsey >has to rely in some part on the writings of Schumpeter and the process >of creative destruction. Schumpeter was one who argued repeatedly, and >I think with more force than Mises or Hayek, that recessions were not >only inevitable, but a good healing process for the economy. I explain >this to students by invoking the debate over whether we should at all >times extinguish forest fires, or whether a naturally caused fire (by >lightning strike) should be viewed as a curative for overgrowth. >Recessions do not hit all industries equally -- those in less productive >sectors are hastened towards decline in a downturn. This frees capital >to other, more productive sectors. Having these induced by a >productivity slowdown or some negative supply shock is like having a >lightning strike in the forest. This is normative. Business cycles aren't all that bad because they clear out the dead wood. Well, I would agree that one favrable aspect of a recession is that it clears out dead wood. (Silver lining to a cloud.) I would also agree that if we have recessions, many of the firms slated for "destruction" over the next few years if there had been no recession get burned up during the the year or two of recession. Yet if there were no recessions ever, firms would still fail. The process of creative destruction could go on. There doesn't have to be idle capacity and unemployed workers for firms to innovate. They hire away from other firms. Firms with obsolete products can't cover costs at the low prices they could charge and maintain output. Firms with obsolete processes can't cover costs when the lower prices to meet those of the competition. They fail without any recession. In conclusion, I don't think recessions are good things because they clear out the dead wood. I think it would be better to have no recessions and still the dead would would fail--just about right. Leaving aside the normative issue, I don't really see how this has much to do with the positive issue. Would recessions occur in a free market system? That firms need to fail sometime is no particular reason to believe that many must fail at once and, further, that the expansion in growing industries does not make it clear that it is more than offsetting the shrinking industries. That is, while statistics might show shrinkage of real output in terms of our measures, the ancedotal evidence would on balance be positive. Claiming that there was not recession observed in the mid-west and a significant one on the coasts implies recession. A major boom in the mid west with very low unemployment extra high prices and huge profits, matched by a recession on the coasts suggest that there is no recession--even if real output declines. =========================================================================== Date: Mon, 13 Jan 1997 13:04:57 -0600 From: King Banaian At 11:44 AM 1/13/97 -0400, you wrote: > Yet if there were no recessions ever, firms would still fail. The >process of creative destruction could go on. There doesn't have to be >idle capacity and unemployed workers for firms to innovate. They hire >away from other firms. Firms with obsolete products can't cover costs >at the low prices they could charge and maintain output. Firms with >obsolete processes can't cover costs when the lower prices to meet those >of the competition. They fail without any recession. Concur, though it may then take longer. It might be that the recession helps overcome the inertia imparted by transactions costs of moving resources to higher valued uses. Plausible, but not yet verified. > In conclusion, I don't think recessions are good things because >they clear out the dead wood. I think it would be better to have no >recessions and still the dead would would fail--just about right. But this begs one of the real questions of business cycle theory: Why do industries tend to expand and contract at the same time? Is there some contagion effect from the dying industries which causes a decline in receipts or production in the healthy ones? Why don't resources move instantaneously from the low productivity to high productivity industries? I think if we believe this is all due to government policies, we should demonstrate how. > Leaving aside the normative issue, I don't really see how this >has much to do with the positive issue. Would recessions occur in >a free market system? The questions above are positive. My normative forest fire answer was to the student who always asks why I would allow those employees of declining industries to suffer unemployment. > That firms need to fail sometime is no particular >reason to believe that many must fail at once and, further, that the >expansion in growing industries does not make it clear that it is >more than offsetting the shrinking industries. Again, the nature of our modern economy is of comovement of industrial production in different sectors. This was more true before World War II than after (with George Selgin's comment on the Romer critique of the data duly noted; I haven't seen this question analyzed with the Romer data yet), but the pattern persists. Victor Zarnowitz, among others, has argued that the movement of the US economy towards services from manufacturing has decreased the amplitude of the business cycle. Perhaps comovement will be less a feature in the future, but it's not clear why. The comovement story, however, has an undesirable feature to it (from my viewpoint): If comovement means declining sectors can lead some healthier firms to fail, you have a potential externality argument for countercyclical government policy. You could argue that a free society would have no comovement and thus no externality, but I don't see a convincing case. --kb Prof. King Banaian Dept. Of Economics St. Cloud State University St. Cloud, MN 56301 http://www.stcloud.msus.edu/~kbanaian/sparky.html "I think two types of power are possible, either a power of ideology, or a power of capital. Ideology is now dead, and today we have a period of transition, from the power of ideology to the power of capital." --Boris Berezovsky, speaking on Russia today.