Yeah, Paul Krugman, a Nobel laureate, finally, let's see what the fillet of the contemporary mainstream economists has to offer against Austrian Business Cycle Theory or, as he likes to call it, "the hangover theory". After all, wouldn't it be convenient to get wasted with no hangover?
ABCT "as worthy of serious study as the phlogiston theory of fire". Great. One thing we have to grant Krugman, he does not set false great expectations, like Lord Keynes or Quiggin, just good old insults.
Krugman does seem worthy of his fame though, as we read that Hayek and Schumpeter were responsible for... "the spread of the Great Depression". Wow, that's indeed new. Turns out there was no "expanding credit and the money supply" back then in 1930s. Unfortunatelly, Krugman fails to provide any source of his revelations. Well, for a Nobel laureate, he probably must have some special insights. 1930s as gold money standard libertarian paradise with no money supply inflation. It's just so shocking ignorance, after all that so many economists have written on this subject. More at the end of this post.
Again, same as with previous social democrat articles we've discussed, there follows some basically accurate description of ABCT. Krugman even admits ABCT "is not a bad story about investment cycles", "except for that last bit about the virtues of recessions".
Krugman then says "a theory is supposed to explain observed correlations, not just assume them." Well, if Krugman actually read some Austrian School theory, he'd know that recessions are conclusions of Austrian School logical reasoning, not assumptions. Assumptions of Austrian School are way more self-evident, like that Krugman prefers leisure to work, so that's the reason he has never cared to read any Austrian School theory. Oh, well, just another Austrian School conclusion.
Krugman wonders, "if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods". So again the generic statement exactly like of Caplan or Quiggin we've discussed previously. What people, what investment goods, what consumption goods? ABCT is not only "implying" but is explicitely saying "that an investment slump should always be accompanied by a corresponding consumption boom", that is, boom in consumption goods that reflect real consumer value scales. Wal-Mart suffers relative to Whole Foods during boom, then vice versa during depression. But obviously you can't expect an immediate and identical increase in consumption as the decline in production. This takes time. Investors are not going to spend all their money on consumption just because their long term projects have become unprofitable. Adjustment takes months (with no government aggression that is). Price mechanisms has to do their work. No entrepreneur has clairvoyance to immediately see their new business opportunities. Hence, higher temporary unemployment must kick in, salary expectations must change, to relay real consumer value scales across the recovering economy.
Krugman does seem to be aware of that when he says that "the best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods." I don't see anything "vague" in that "suggestion". But Krugman still has trouble to accept this as he asks "but in that case, why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment?". Simple, because there is no upward wage stickness. There's a lot of employee turnover during boom, but employees happily choose higher salaries in overiflated investment good sector over their current jobs, and there is no problem of employers shy of layoffs, so there is not even frictional unemployment.
Then follows the familiar keynesian explanation of depression. People somehow start to like cash more. "A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time." Why doesn't Krugman simply advise central bank to start printing ugly bank notes then? Surprisingly instead, Krugman's advice is to "junk the bad investments and write off the bad loans". Wow, isn't that what Austrians have been advising in the first place?
Nothing of much importance in next paragraph, just the usual rambling about conservatives who don't like printing money. I guess Libertarian Party would have to dissolve if our conservatives were actually so... libertarian. Some cutting edge psychological analysis too, as "some people probably are attracted to Austrianism because they imagine that it devalues the intellectual pretensions of economics professors". Krugman does seem to imagine himself above any layman (or even fellow economists') verification of his intellectual legitimacy.
And we even get Japanese example! "The truth is that the Japanese have been remarkably willing to make hard choices, such as raising taxes sharply in 1997." Yeah, let's raise government tax income so we can match inflated government expenditures. Hard choice indeed...
Finally at the end of his article, Krugman explains that "the Great Depression happened largely because policy-makers imagined that austerity was the way to fight a recession". Obviously, a quote from Rothbard should do, and only about how the massive inflation began, but Krugman, just educate yourself, anywhere, really:
Dr. Anderson records that, at the end of December, 1929, the
leading Federal Reserve officials wanted to pursue a laissez-faire
policy: “the disposition was to let the money market ‘sweat it out’
and reach monetary ease by the wholesome process of liquidation.”
The Federal Reserve was prepared to let the money market find its
own level, without providing artificial stimuli that could only prolong
the crisis. But early in 1930, the government instituted a massive
easy money program. Rediscount rates of the New York Fed
fell from 4 1/2 percent in February to 2 percent by the end of
the year. Buying rates on acceptances, and the call loan rate, fell
similarly. At the end of August, Governor Roy Young of the Federal
Reserve Board resigned, and was replaced by a more thoroughgoing
inflationist, Eugene Meyer, Jr., who had been so active
in government lending to farmers. During the entire year, 1930,
total member bank reserves increased by $116 million. Controlled
reserves rose by $209 million; $218 million consisted of an
increase in government securities held. Gold stock increased by
$309 million, and there was a net increase in member bank
reserves of $116 million. Despite this increase in reserves, the total
money supply (including all money-substitutes) remained almost
constant during the year, falling very slightly from $73.52 billion
at the end of 1929 to $73.27 billion at the end of 1930. There
would have been a substantial rise were it not for the shaky banks
which were forced to contract their operations in view of the general
depression. Security issues increased, and for a while stock
prices rose again, but the latter soon fell back sharply, and production
and employment kept falling steadily.
A leader in the easy money policy of late 1929 and 1930 was
once more the New York Federal Reserve, headed by Governor
George Harrison. The Federal Reserve, in fact, began the inflationist
policy on its own. Inflation would have been greater in 1930
had not the stock market boom collapsed in the spring, and if not
for the wave of bank failures in late 1930. The inflationists were not
satisfied with events, and by late October, Business Week thundered
denunciation of the alleged “deflationists in the saddle,” supposedly
inspired by the largest commercial and investment banks.