Quote:
Originally Posted by u-Bob
The essential difference between the Neo/New Keynesian interventionists and the pro-free market Austrian School (in regards to this issue) is whether or not an artificial boom is sustainable.
New Keynesians agree that pumping new money into the economy creates an artificial boom. Even Krugman admitted that the housing bubble was caused by the Fed's easy money policies. In fact Krugman was one of the people who actually called for a housing bubble...
The problem with artificial booms (in the Austrian view) is that they are just that: artificial. There's nothing backing up that new money. The result is a shift in resources from where they would normally go into sectors that would otherwise be obvious to be unsustainable.
The interest rate is essentially the price of money. if you take a cab and pay $50 for that,t hen that $50 was the price for a cab ride. If you borrow $500 and pay back $550 then the price of that $500 was $50 or 10%.
Obviously people will be more inclined to borrow money when the price is lower then when it is higher. Artificial low interest rates leads to mal-investment. People start projects they would otherwise not have started. They start projects that are not sustainable in the long run. Why are they not sustainable? Because the price of money is artificially being kept low and the Gov (central bank) can't keep doing this forever (or they would cause hyperinflation.. think Zimbabwe). When the price of money goes up again, those companies that couldn't exist without cheap/free money run into problems.
What we need is the market to do its work. What we need is liquidation of bad investments.
If no one is buying the products you are selling then that is the market giving you a signal. It's telling you that no one is willing to buy those products at the price you are selling them.
If you just invested $1000000 in a new carriage factory and except for a few Amish no one is buying your horse drawn carriages then it doesn't make sense to continue borrowing more cheap money to keep your factory going but then it's time to scale things down. Then it's time to sell some (or all) of the wood, leather,metal, tools etc you intended to use to build carriages. Yes, you probably won't be able to recuperate your $1000000 investment (some of the wood can only be sold as firewood (at a lower price than you expected to get for it if it was part of a finished carriage), some of the tools are too specialized to be used for something other than building Amish style carriages and can only be sold as scrap metal etc), but that is the great thing about the free market: it rewards responsible behavior and it punishes bad behavior. Maybe you should have started with a small factory or you could have started building those carriages in your garage. And you could have expanded your operation if things went well, but no... because money was cheap you overreached and now you end up paying the price for that)
Keeping unsustainable business in business by putting them on an IV with cheap money does not provide more wealth. It does not provide more goods and services that people want and are willing to pay for. Keeping unsustainable business in business only harms sustainable and new business because it raises the prices of the resources they are competing for (skilled laborers, wood, oil, leather etc).
And it gets even worse when they start directly bailing out companies. Because that way they totally remove all responsibility.
(I'm off, i'll be back on monday)
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As far as an infrastructure stimulus plan being artificial, that's not entirely true. Even conservative estimates put return on smart infrastructure investments at 2.5-3% due to increased productivity and other factors over time. Modernizing infrastructure gives short term gains in jobs and consumer spending, but it also gives long term gains due to the return caused by living in a modern and more efficient society. High speed rails, nation wide high speed wifi, modern schools, etc. These things all allow us to be more productive, educated and innovative which gives us long term economic stimulus.
As far as cheap money and bailing out business and propping up companies, I never suggested any of that.
Don't forget, our economy was relatively normal until we decided to wage two of the longest wars in American history....simultaneously. Then we allowed the banking industry to totally wipe out a majority the equity every American had in their home, after which we gave the banks all the money they lost right back. It's not like we need to re-invent the wheel here. We just need to right the ship. America has worked for a pretty long time, it's just that a few stupid people at the top made some incredibly short sighted decisions, some for ideology, and some for greed.