Paul Krugman Says: Recessions Are Evil!

His strictures against neo-Hayekian economics. It is the best refutation of investment-overshoot-plus-frictional-adjustment around. From BobbyK's Paul Krugman archive:

THE HANGOVER THEORY: Are Recessions the inevitable payback for good times? SYNOPSIS: The constantly occuring idea of helpful recessions is incoherent and faulty

A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle--a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking--not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

The hangover theory is perversely seductive--not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted--for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality--with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression--with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity--of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes--investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.

Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles.... But... [w]hy should the ups and downs of investment demand lead to ups and downs in the economy as a whole?... [T]he key to the Keynesian revolution in economic thought--a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles--was John Maynard Keynes' realization that the crucial question was not why investment demand sometimes declines, but why such declines cause the whole economy to slump.... As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income.... [I]f people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods--implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?

Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem.... But... why doesn't the investment boom--which presumably requires a transfer of workers in the opposite direction--also generate mass unemployment?...

A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?

The hangover theory, then, turns out to be intellectually incoherent.... Few Western commentators have resisted the temptation to turn Asia's economic woes into an occasion for moralizing on the region's past sins. How many articles have you read blaming Japan's current malaise on the excesses of the "bubble economy" of the 1980s--even though that bubble burst almost a decade ago? How many editorials have you seen warning that credit expansion in Korea or Malaysia is a terrible idea, because after all it was excessive credit expansion that created the problem in the first place?

And the Asians--the Japanese in particular--take such strictures seriously.... [T]hey are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. The Great Depression happened largely because policy-makers imagined that austerity was the way to fight a recession; the not-so-great depression that has enveloped much of Asia has been worsened by the same instinct. Keynes had it right: Often, if not always, "it is ideas, not vested interests, that are dangerous for good or evil."

Comments

[RedCharlie]

Before there was http://delong.typepad.com there was http://www.pkarchive.org which I read daily even though PK only writes his column twice a week.

So I've read this before, a few times probably.

I can understand the bit about this being a demand/supply problem. In a recession, the supply of goods exceeds demand and the demand for money exceeds supply. This makes sense.

But in reply to "Why should this require that perfectly good productive capacity be left idle?" couldn't one point to excess inventory? I mean, look at the current housing climate. We have surplus inventory of houses for sale, so doesn't that mean that homebuilders need to build fewer houses until inventory is reduced to "normal" levels?

I realize that both recessions and booms cause dislocation/reallocation of resources, so some homebuilders go do something else in a housing slump, just as homebuilders hire lots of new workers (who were presumeably doing something else) during a housing boom. But how does one work this out for the economy as a whole? I'm just looking for a succinct summarization, from someone more knowledgeable than myself (tho' I confess that's not a hard hurdle to clear!)

[Ginger Yellow]

"And the Asians--the Japanese in particular--take such strictures seriously.... [T]hey are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. "

I'm no expert, but this sounds off to me. Japan has had effectively zero interest rates for a decade now, and continued its many white elephant (and other more sensible) public works projects well into the recession. It even resorting to just giving people "free" money at one point.

[bailey]

Message to PK, BDL & BobbyK: "why not simply increase the supply of money?"

That's easy - because our leading macroeconomists have for decades educated us to the HORRORS of inflation.

Oh I'm sorry, I forgot - we have no inflation; we defined it away years ago.

[bigTom]

I don't see blaming current non-ideal conditions on past excesses as a bad thing. Blindly applying moral punishment however is just plain stupid. To the extent that excesses drive the business cycle, and to the extent that we believe the cycle is harmful, public policy should be strive to damp down the amplitude of the cycle. Damping means to reduce the amount of departure from steady-state behavior. It seems that during the past couple of decades the central bankers have become a lot better at doing this than in the past. The real concern is if the current central bank system might be running hedge-fund type risks, i.e. doing very well in normal times but catastrophically vulnerable to an abnormal shock.

I have no clue how to answer the last question, but I think it a vital one.

[Matt]

The question, why should adjustments in ivestments effect the whole economy?

As far as Keynes' arithmetic, he is correct, if we limit the class of economies to real valued kernels. If assets and liabilities were accuratley complex numbers, then we find mispricing apparent and this results in supply shocks and inventory mis-management, and that generates cycles.

Economies where real kernel approximation works are probably those with relatively low cost of natural resources. We don't have that. Those economies can continually expand. Once resource prices rise, the cyclic volatility becomes apparent relative to the continous growth.

[andyoufalldown]

RedCharlie: The first part of the answer to your question is the assumption that the fixed costs of production represent a fairly substantial part of the total cost of production, so once those investments have been made, the market would have to totally collapse in order to make it efficient to shutter the factories, mothball the vehicles, etc.

(Example; imagine a machine that costs $1M, which requires a single worker, who works on it 2K hours a year at $10/hr. In order to make the initial investment worthwhile, you must expect to sell a year's worth of the final product for $70k [in order to pay the worker and make 5% on the machine], but once the machine has been made, you only need to be able to sell the product for $20K, to make back the wage.)

The second part of the answer is that there is a bit of circularity built into your premise about inventories. It is true that, if there is a recession or other form of economic crisis, sectors that are holding large inventories will stop producing and simply try to liquidate their inventories. *But* this is very different from saying that an economic crisis will *consist of* sectors stopping production because they would rather just liquidate overly large inventories.

[Neil B.]

Let's not be too hard either on the people who claim that the hurtful recession racket is not just a fault of crank ideologues, but a scam to make money off the pain.

[anne]

Ginger Yellow -

While the Japanese economy was slowing in the turn to 1990, there was a stock market and real estate bubble that the central bank countered by raising interest rates. Stock began to fall immediately, with real estate prices holding to 1992. Growth though was slowing the while.

Central bank policy was not effectively changed before 1994, when a financial problem, a problem by then of deflation, had become a problem of near zero growth. However, by 1994 demand for liquidity was minimal and lowering interest rates had minimal effect.

Japan continued to grow painfully slowly from 1994 because of government deficit spending. The painfully slow growth continued through the decade.

[Craig Tindale]

It just proves Krugmans complete ignorance of Austrian economics not much else , the Austrians were wrong on some things but tabloid economic analysis like this doesnt help one bit .

Ok yeah Schumpeter, Hayek and Mises were sun worshipping pagans and this generation has go it all perfectly correct.

Trouble is when America is in ruins the Austrian warnings will sound a lot clearer.

Yeah small men can write off great men with small words but history will eventually speak the truth.

[c.h.bui]

America is FREEDOM. WE DO GET A CHOICE TO CHOOSE WHAT WE WANT TO DO AS LONG WE DON'T BREAK THE CONSTITUITION, RIGHT?

[c.h.bui]

ARE THERE OTHER TRUTHS THAT THE AMERICAN NEED TO KNOW ABOUT? COME TO THINK ABOUT IT, I THINK NOW THAT U.F.O PROBABLY EXIST JUST FOR US TO THINK ABOUT.

[c.h.bui]

GUESS NOW THAT WE DONE ENOUGH STUDIES THAT FLYING CARS SHOULD BE A PROTOTYPE FOR US?
WHEN WILL WE SEE IT?
MAYBE WE HAVE LIKE A STARGATE WE CAN TRAVEL THROUGH THAT WE DON'T NEED CARS.
TECHNOLOGIES? WHAT CAN WE DO WITH IT? FOR ONE, MAYBE NOTHING, BUT OTHERS , THEY CAN PROFIT FROM YOUR MISTAKE. ONE IDEA, SPARK A THOUSAND OTHERS!!!

[don majors]

" As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income...."

Well it's not simple arithmetic ... try simple algebra: d=st

If the check is in the mail (not), then "t" is undefined. That means payday is delayed. you can absorb a few "check is in the mail" promises but eventually the time comes when you wake up to "t=0 and d/t= infinity." you can't meet your obligations and the economy and legal processes need time to adjust the imbalances.

Regarding the Austrian/ Hayekian notion: "Powerful as these seductions may be, they must be resisted--for the hangover theory is disastrously wrongheaded"

Am I missing some point re: Austrian hangover explanation. It seems reasonable to me. It's all in timing and societal processes for stabilization.

[andres]

anne:

"Central bank policy was not effectively changed before 1994, when a financial problem, a problem by then of deflation, had become a problem of near zero growth. However, by 1994 demand for liquidity was minimal and lowering interest rates had minimal effect."

Hmmm. I must have missed something. If demand for liquidity is minimal by 1994 then lowering interest should have had a large effect in stimulating physical capital formation. If you're not so scared about your ability to meet financial obligations that your demand for liquidity is infinite (for all practical purposes), then at least some of your revenues would be invested.

It seems to me that falling interest rates in 1994 did not increase spending in Japan because the credit system was too seized up to generate either increased consumption or physical investment (ie a _high_ liquidity preference), and subsequently interest rates fell to the near-zero levels indicative of a classic liquidity trap, and could thus not fall further.

[RedCharlie]

For all his shrillness concerning the U.S., Krugman's specialty deals with foreign economies, and he has written a bit on Japan. I think Anne has it right I think. If one pokes thru the pkarchive, you'll find that for a while there he was quite worried that Japan was in the proverbial liquidity trap. That is, once you lower the interest rate to 0, you are out of maneuvering room.

IIRC, Krugman thought that the problem was that of perceived deflation, that everyone knows that the coming demographic crisis in Japan will dwarf the retirement of the U.S.babyboomers, and this (don't ask me why) leads to an expectation that the economy will contract and that money will be worth more later (i.e. deflation) no matter what the interest rate is now.

Krugman's proposed solution was a sort of deliberate recklessness, that to really break the perception that money would be worth more tomorrow, the JCB would really have to commit to deliberate, substantial, and persistent inflation (not easing of credit now with the expectation of tightening back in later). People would not really start spending their yen unless they really believed that inflation would eat at them if they didn't.

And thanx to andyoufalldown, your explanation does help. I guess I'm caught up in the difference between slowing down a bit and "productive capacity [being] left [completely] idle". It makes perfect sense that as long as they can sell their products for enough to pay for wages and inputs, factory owners are better off producing than idling. But if people are buying less it also makes sense to throttle back production, to keep from driving prices into the ground, at the very least. Of course, that's where increasing the money supply comes in, to keep people buying....

[Anurag]

Could one of the prior commenters on this thread explain how/why the Austrians were right? Just working through a simple example, rather than asserting it. I'd really like to understand the model.

[Bill]

Paul Krugman makes a lot of excellent points. My only disagreement is with the argument against frictional issues causing unemployment. Expansions tend to last (lately at least) 5-9 years, recessions last 2-3 quarters. So the transitioning of workers INTO the booming industry doesn't cause dislocation because it happens over a longer period of time. Some of the manufacturing firms that lost workers to construction will never come back - and that's the best reason to lean harder against bubbles than we've done over the last 2 decades.

[andyoufalldown]

To answer don and RedCharlie:

The simplified version of the Austrian theory of a real business cycle is that, for whatever reason (mistiming being a popular explanation), investors over-invest in fixed capital. So even though the marginal investor wants a 5% return, by the time his $100M factory is completed, he can only make $3M in profit off of it each year.

Objection: So what? Individual entrepreneurs may go bust, and specific investment projects might pass from hand to hand, but all of that fixed capital still exists, so despite the unpleasant readjustment when the investment projects are revalued, GDP should continue to grow, but at a slower pace than before.

Austrian Reply: Well, when the readjustment occurs, a great deal of manpower and resources employed in the production of capital goods needs to be retooled for the production of consumer goods. That redirection of effort can only happen in a sloppy and haphazard fashion, so resources are used less efficiently due to friction while the economy readjusts. Thus factories are unused, people unemployed, and GDP shrinks.

Rejoinder: OK, but then shouldn't we see the exact same dynamic when the economy shifts from the production of consumer goods back to the production of capital goods?

Austrian Riposte: Praxeology! Praxeology! No escaping it for me!

[anne]

http://web.mit.edu/krugman/www/jpage.html

May, 1998

A SPECIAL PAGE ON JAPAN
By Paul Krugman

The state of Japan is a scandal, an outrage, a reproach. It is not, at least so far, a human disaster like Indonesia or Brazil. But Japan's economic malaise is uniquely gratuitous. Sixty years after Keynes, a great nation - a country with a stable and effective government, a massive net creditor, subject to none of the constraints that lesser economies face - is operating far below its productive capacity, simply because its consumers and investors do not spend enough. That should not happen; in allowing it to happen, and to continue year after year, Japan's economic officials have subtracted value from their nation and the world as a whole on a truly heroic scale.

The fault does not, however, lie merely with those officials. Japan has also been badly served by the economics profession, both in Japan and outside. The great majority of economists - including those who specialize in issues of economic stabilization and growth - seem oddly uninterested in Japan's plight, as if the failure of conventional macroeconomic policy in the world's second largest economy were a subject of merely parochial interest, with no lessons for the rest of us. Of those who do make pronouncements on Japan, many if not most have taken the easy way out: blaming the victim, absolving themselves of responsibility for proposing solutions by asserting that Japan's problems are deep, structural, beyond the reach of technical fixes. Well, maybe; but maybe not. Sometimes big problems have small causes; sometimes a simple technical fix can work miracles.

Last spring I decided to sit down and think seriously about Japan's ills, putting aside conventional wisdom and my own prejudices, following the logic of economic analysis wherever it led. And it led to a surprising conclusion: that there is indeed a simple fix for Japan's slump - and that the structural obstacles to a quick recovery lie not in the economy itself but in the minds of policymakers.

What is particularly remarkable about the debate over Japan is that it is a case where straightforward economic analysis and policy orthodoxy are in direct conflict. If you apply the most conventional of macroeconomic models to Japan's unusual plight, you come up with recommendations that are anathema to central bankers and finance ministers. And in this case, I am firmly convinced that the models are right and the officials are wrong.

This page offers direct links to those of my writings that bear directly or indirectly on the problems of Japan. I group these essays into "models" - conceptual frameworks (some but not all mathematical) that attempt to make sense of Japan's predicament - and "diatribes", which focus more on the question of why Japan's policymakers (and too many economic pundits, Japanese and Western) have been unwilling to break out of the habits of thought that are, in my view, the only reason that predicament persists....

[shah8]

Look, public intellectual economists are usually akin to priests of some crank religeon that benefits the people s/he's fronting for.

There are several issues that are confusing each other.

1) Austrian school (as well as Chicago school) baddies are primarily interested in collecting capital into favored hands. Deflationary recessions are profitable for the kind of people these guys represent (mostly in the post US civil war to WWI). The Jay Goulds, Rockefellers, and Carnegies of the era used their control of scarce currency to sieze value added property or assets grown during during not so harsh times (with circumstances that enforce debt).

2) This system got trashed as industrialization increasingly occured, because industrial assets, unlike farming land or mines or simple factories, progressively became much more sensitive to a use-it-or-lose-it dynamics as well as becoming more sensitive to supply disruptions. This meant that asset raiding became much more likely to set off deflationary cascades.

When this dynamic became outmoded, it left alot of old money increasing encroached socially by the new bunch of industrialists. They always advocate the ancien regime as a means to return to status.

3) Most anyone with cash instead of assets on the table is going to advocate "tough medicine". People should check out how much cash there is out there in the world, controled by how few people. They'd support the gold bugs full-stop.

4) The issue in Japan is the near total control of the populace by the corporations. More, cheaper money will not solve the problem. What *will* solve the problem is the elimination of various ass-raping laws and customs, because japanese corporates are firmly convinced in total mercantilism. Suggestions? Easy immigration, opening more markets to foreign firms, *mandating 35-40 hour work weeks* with real penalties for cheating, aggressively stop gender and age discrimination, *new bankrupcy laws* that makes it much easier to declare bunckrupcy, and more work to increase the number of intermediate regional companies (other than construction) etc, etc.

The issue in Japan has nothing to do with how much *cash*. It is mostly to do with *how useable* cash is. If people cannot price shop easily in the face of location/market sector monopolies, then each yen is missing a percentage of it's value, independent of how many yen there are (the cash to go to other places to shop, using an intermediate shopper).

If people are stuck at work 12-16 a day, regardless of their productivity (not that great), then they are not in a position to consume, or invest in their own lives (like say, picking out a costume for their daughters for some mask party, or post undergrad study). Constraining self time is also deflationary, and intentionally so.

One of the big issues that's constraining Japan is their harsh bankrupcy laws. Many people cannot leave to search for other opportunities because they are stuck in houses that they have minimally growing capital in...Also, everyone has to save for rainy days to make sure they are personally solvent, which lowers the ability to take on risk.

The japanese crisis is primarily about Japan Inc being in crisis. If the regime stops treating japanese people as being members of a nationalist enterprise, most of the problems can be resolved.

[JR]

I concur with Craig. Krugman has set up a strawman version of Austrian theory and then tried to knock it down with rhetorical Keynesiasm.

While Krugman makes multiple misrepresentations (intentional or not) of Austrian theory, the most obvious and poignant is his claim that Austrians believe in "over-investment" rather than "mal-investment." Launching from this misrepresentation, he questions how Austrian theory can explain that over-investment leads to unemployment.

Starting from the beginning: a person (or business) can use money in three ways: consumption, cash reserves, or investment. The decision on how much to consume versus save (cash reserves + investment) is determined by time preferences (do I want more stuff now or later), and the amount of money to keep in cash reserves is determined by the demand for money (how much liquidity do I want to have).

Note that time preference is critical, as it determines interest rates. If people decide to spend less and put more money in the bank, this drives down interest rates and increases investments, and vice versa.

Austrian theory of a boom - bust cycle is based on MAL-investment. Mal-investment occurs when interest rates are artificially low - the Fed holds rates below what the market would set - which leads to increased investment and a growing money supply. It is not over-investment because this increased investment occurs in capital goods higher up the production cycle versus consumer goods. Why? Because a drop in interest rates implies that consumers are saving more and spending less, and therefore they will be increasing spending in the future.

We now have our boom. As capital good manufacturers ramp up, they drive up the prices for their factors of production, i.e. other capital goods and wages for workers in the capital goods industry. Inflation occurs due to the expanding money supply.

And now the problem sets in - consumers' time preferences haven't necessarily changed as implied by the lower interest rate (remember, the Fed set the lower rate). There is no increase in consumer demand. Retailers don't increase their purchases of capital goods, their suppliers don't increase their purchases of capital goods, and so on up the chain of production. Capital goods manufacturers who ramped up during the boom using cheap money now face falling prices for their goods. They lay people off to reduce costs (or they may attempt to reduce wages). A general downturn occurs.

Now the Fed is stuck. Because it grew the money supply via lower interest rates, inflation occured. If it reacts to the crisis by lowering interest rates again, it risks further inflation and/or a setup for a bigger fall down the road. If it raises interest rates, it may make the economic downturn worse. Basically, the pickle Bernanke is in right now.

[anne]

Shah, makes an interesting point that I have wondered about but not looked to. Who did the Austrians represent? May sense has been the school was always after bashing New Deal programs in the same manner as and for the the Mellons were. Worth looking to.

The argument about Japanese business structure still being a limitation, is not clear to me however. When families of Japanese students visit, the argument always goes on with no resolution. Remember that Japanese growth slowed markedly, but the deflation made slower growth tolerable and middle class Japan is awfully comfortable.

[anne]

"Now the Fed is stuck. Because it grew the money supply via lower interest rates, inflation occured. If it reacts to the crisis by lowering interest rates again, it risks further inflation and/or a setup for a bigger fall down the road."

Yes; this is Austrianism, but no and no and no in answer to each charge. Inflation was and is remarkably well-contained, with minimal risk for more, and the Fed is not in the least stuck though I am still puzzled about possibilities.

[Shah8]

Hey there Anne...Did make an oblique reference to all those people who viewed FDR as a class traiter.

Next time you see some of the japanese that you refer to, ask about their shopping trips overseas, to Saipan and Hawaii, among other places. Think about just who could afford to get the travel fares to make those savings.

Also ask about jokes about the long working hours, one might be surprised.

Check out the book "Shutting Out the Sun" The approach it makes is wrong, but it documents how the long depression actually affected the citizens. There are japanese modes of failures that isn't especially apparent to people living overseas...

[christofay]

Inflation was not contained during the Greenspam years; that's why it's called Greenspam. The govt has succeeded in focusing attention on one metric that they create. The manufactured products that are contained in the metric have been influenced by the introduction of especially China into our sales channels. I know poeple who are in the business of buying from China to stock shelves of Best Buy, Walmart and more beauties who still expect periodic price discounts.

The metric does not include living expenses that have been increasing, health insurance, gas, food.

There have also been two spectacular bouts of asset price inflation, the tech bubble and the housing bubble.

If your wages and salaries have been stagnant for a decade, who cares about the falling price of a skirt made of crappy materials in Walmart?

[anne]

Shah, do I ever know and not know. I listen to Japanese families trying intospectively to transmit a sense of the culture they are completely steeped in and understand only all the complex ambivalencies.

We need to watch some Kurosawa, I think. What should we watch?

[anne]

http://query.nytimes.com/gst/fullpage.html?res=9C0CE5D7103AF937A1575BC0A966958260

August 24, 1990

Kurosawa's Magical Tales of Art, Time and Death
By VINCENT CANBY

A solemn little boy comes out of his house one rainy morning to find the sun shining. His mother, practical and no-nonsense, looks up at the sky and says that foxes hold their wedding processions in such weather. ''They don't like to be seen by people,'' she says, and goes about her business.

A solemn little boy comes out of his house one rainy morning to find the sun shining. His mother, practical and no-nonsense, looks up at the sky and says that foxes hold their wedding processions in such weather. ''They don't like to be seen by people,'' she says, and goes about her business.

The casual remark is enough to send the boy into the forest, where the trees are as large and imposing as California redwoods. Even the ferns are taller than he is. The rain glistens within the shafts of sunlight. The boy moves with a certain amount of dread. This is forbidden territory.

In a moment of pure screen enchantment, a strange wedding procession slowly comes into view, the priests in front, followed by the bridal pair, their attendants, their families, their friends and their retainers. They walk on two feet, like people, but that they are foxes is clear from the orangey whiskers on their otherwise rice-powder-white, masklike faces.

The procession appears to be choreographed. The foxes march in unison to the hollow clicking sounds of ancient musical instruments. Every few steps their haughty manner becomes furtive when, as if on cue, they abruptly pause, cock their heads to the side, listen, and then move on.

This is the sublime beginning of ''Sunshine Through the Rain,'' the first segment of the eight that compose ''Akira Kurosawa's Dreams,'' the grand new film by the 80-year-old Japanese master who, over a 40-year period, has given us ''Rashomon,'' ''Throne of Blood'' and ''Ran,'' among other classics.

One might have expected ''Dreams'' to be a summing up, a coda. It isn't. It's something altogether new for Kurosawa, a collection of short, sometimes fragmentary films that are less like dreams than fairy tales of past, present and future. The magical and mysterious are mixed with the practical, funny and polemical.

The movie is about many things, including the terrors of childhood, parents who are as olympian as gods, the seductive nature of death, nuclear annihilation, environmental pollution and, in a segment titled simply ''Crows,'' art....

[christofay]

The Fed is stuck.

The over spending in housing is Austrian mal-investment, isn't it? The Robert Shiller index of housing prices is a picture of the over investment. The example is right there.

No one invests in productive enterprises in the U. S. anymore, do they?

We invest in asset bubble inflation.

[don majors]

andyouallfalldown:

"Praxeology! Praxeology! No escaping it for me"

I guess there is truth in "where you set is where you sit" in assessing the identitiy of beneficiaries of New Deal Policies. And, pumping up credit/money supply to stimulate spending stimulates my liberal economic juices. But it's too scary for me to make that Praxceological decision.

[JR]

RE: Anne -

I defer to christofay.

[christofay]

"pumping up credit/money supply to stimulate spending" is the Bush years

a couple hundred thousand guns, many turned against us

tens of billions of reconstruction aid 100% spent by well-connected companies with 40% of the work completed

premium priced Prius boxed in at the intersection by a half dozen SUVs

empty track homes trying to turn themselves back to nature. the garage a fox den. the basement a trip to Florida for field mice and chipmunks. was the field drained, the swimming pool can be a wonderful place to breed bugs.

[anne]

I listen and ask little, but these are families who are as likely as not to be passing through to Berlin and, yes, there were pictures of shopping for Kimonos in Hong Kong only weeks ago. So, I know them and do not know them. They are awfully kind.

Lately there is much talk about introspection and psychology, which seems to surprise and please them. A mother contentedly going going through psychotherapy which would have been unthinkable a decade ago.

[anne]

http://query.nytimes.com/gst/fullpage.html?res=EE05E7DF1730A42CA44A4CC2B7799D8E6896

December 27, 1951

Rashomon
By BOSLEY CROWTHER

A doubly rewarding experience for those who seek out unusual films in attractive and comfortable surroundings was made available yesterday upon the reopening of the rebuilt Little Carnegie with the Japanese film, Rasho-Mon. For here the attraction and the theater are appropriately and interestingly matched in a striking association of cinematic and architectural artistry, stimulating to the intelligence and the taste of the patron in both realms.

Rasho-Mon, which created much excitement when it suddenly appeared upon the scene of the Venice Film Festival last autumn and carried off the grand prize, is, indeed, an artistic achievement of such distinct and exotic character that it is difficult to estimate it alongside conventional story films. On the surface, it isn't a picture of the sort that we're accustomed to at all, being simply a careful observation of a dramatic incident from four points of view, with an eye to discovering some meaning—some rationalization—in the seeming heartlessness of man.

At the start, three Japanese wanderers are sheltering themselves from the rain in the ruined gatehouse of a city. The time is many centuries ago. The country is desolate, the people disillusioned, and the three men are contemplating a brutal act that has occurred outside the city and is preying upon their minds.

It seems that a notorious bandit has waylaid a merchant and his wife. (The story is visualized in flashback, as later told by the bandit to a judge.) After tying up the merchant, the bandit rapes the wife and then—according to his story—kills the merchant in a fair duel with swords.

However, as the wife tells the story, she is so crushed by her husband's contempt after the shameful violence and after the bandit has fled that she begs her husband to kill her. When he refuses, she faints. Upon recovery, she discovers a dagger which she was holding in her hands is in his chest.

According to the dead husband's story, as told through a medium, his life is taken by his own hand when the bandit and his faithless wife flee. And, finally, a humble wood-gatherer—one of the three men reflecting on the crime—reports that he witnessed the murder and that the bandit killed the husband at the wife's behest....

[andyoufalldown]

JR -- Is your claim that the Austrian theory of the business cycle holds that firms are smart enough to deduce future demand from current interest rates, but too stupid to figure out that interest rates are affected by government policies as well as consumer time-preference? I have never heard anyone offer that interpretation of ABC theory, but that would be a strange theory indeed.

Even so, your version of the ABC doesn't overcome Krugman's objections. Where is the downturn in production coming from? (Remember, a recession isn't a decrease in the *rate* of growth, it's a decrease in total production.) If it is coming from frictional forces (when the capital-good manufacturers break their contracts for labor and other factors, it takes a while to find new buyers in the consumer-good sector), you should see the *exact same* bust earlier in the cycle, when rising prices (driven by the capital-goods sector) force firms that make consumer goods to cut back, leading to lay-offs and so on. Thus the ABC is a bust-bust cycle.

[anne]

Christofay is clever, and I am too unsure to argue and prefer thinking along. As in Rashomon, there are many stories to be told from many perspectives. Remember though to respect the use of fiscal policy in Japan to insulate the middle class effectively, as I argued with Brad DeLong several years ago.

[anne]

Really, now, I will think this evening in terms of Rashomon, in differing perspectives, which may help considerably. Kurosawa is all brilliance for decades. So, Shah has given us a fine idea in thinking to the Japanese experience a little. Nice.

[christofay]

Isao Takahata, don't think, feel, and after the images and feelings have sunk in for a few weeks, think

Grave of the Fireflies, Princess Mononoke, Spirited Away. Made more recently in a form that will subvert the adult perspective. Cartoons for friggin sakes. What an antidote to the era of consensus thinking by the DC wise men

There has been a book published within the last year about post-war Japan. Grinding misery. What was the best public space to go to while you wait to starve to death. It's a book for the grown-ups. I have to dig out the title tonight at home.

In the meantime we can enjoy the good news coming out of Iraq

[christofay]

Donald Keene, Anthology of Japanese Literature

See "An Account of My Hut," and "Three Poets at Minase"

Take it out of the library. Check to see when was the last time the book was borrowed if there still is a place where the book is stamped in the book cover

[christofay]

John W. Dower, "Embracing Defeat: Japan in the Wake of World War II" (Norton, 1999)

sadly might be necessary to read

[anne]

Christofay tells of the work of Isao Takahata, of which I was unaware but will not be for long.

Review Summary -

Pom Poko (1994)

Renowned animation director Isao Takahata spins this tale about a pitched battle between Japanese folkloric figures and housing developers at the edge of the Tokyo sprawl. The tanuki -- a badger-like creature often portrayed with big round eyes, a large Buddha-like belly, and long pendulous testicles resting by its feet -- is a beloved figure in Japanese myth, viewed both as a fun-loving bringer of fortune and a shape-changing trickster. Pom Poko opens with a group of tanuki fighting amongst each other for the increasingly scarce resources of their forest. Soon the group realizes that the real enemy is not their fellow tanuki, but suburban sprawl. Lead by their tough-talking matriarch, Oroku Baba, they use their lycanthropic abilities in a campaign to thwart the developers. Suddenly tarps fall on windshields and obstacles appear before bulldozers, sending the lot careening off the road and into a gulch. Unfortunately, the tide of progress is not that easily turned. Will the plucky tanuki keep their pastoral idyll?

-- Jonathan Crow

[anne]

John W. Dower, an MIT historian and specialist on modern Japan was a voice against the war in and occupation of Iraq. Recently the President has used the ttransition of Japan during occupation, as written about by Dower, as a rationale for occupying Iraq, to which Dower has strongly objected.

[anne]

http://www.nytimes.com/books/99/07/04/reviews/990704.704stockt.html

July 4, 1999

This Space Occupied
By J. A. A. STOCKWIN

EMBRACING DEFEAT
Japan in the Wake of World War II.
By John W. Dower.

The Allied occupation of Japan was by almost any standards an extraordinary exercise of power by victors over vanquished. Even if Gen. Douglas MacArthur's assessment, ''an unprecedented revolution in the social history of the world,'' is regarded as hyperbolic, the ambition that underlay the whole enterprise -- at least in its earlier phases -- was no less than to reshape alien and Oriental Japan on the model of a Western democracy.

In ''Embracing Defeat,'' a magisterial and beautifully written book, John W. Dower, a historian at the Massachusetts Institute of Technology, throws light into darker corners (sometimes very dark corners) of Japan between August 1945 and April 1952 and tries to assess the broader meaning of the experience in the context of modern Japanese history. In a formulation reminiscent of Eric Hobsbawm's ''short 20th century'' idea, he sums up his perspective in terms of ''a cycle of recent history that began in the late 1920's and essentially ended in 1989. When this short, violent, innovative epoch is scrutinized, much of what has been characterized as a postwar 'Japanese model' proves to be a hybrid Japanese-American model: forged in war, intensified through defeat and occupation and maintained over the ensuing decades out of an abiding fear of national vulnerability and a widespread belief that Japan needed top-level planning and protection to achieve optimum economic growth. This bureaucratic capitalism is incomprehensible without understanding how victor and vanquished embraced Japan's defeat together.''

In other words, unlike some in Japan and elsewhere who have tended to shrug off the occupation experience as full of sound and fury but in the long perspective of history a temporary diversion from unidirectional Japanese history, Dower sees it as much more than that: Japan and the United States were (and are) inextricably intertwined. On the other hand, he has little time for the view that MacArthur and his subordinates bestowed democracy on Japan and the Japanese lived happily ever after. Indeed, much of the book is devoted to dissecting the occupation's pretensions, as well as many of its practices.

He is scathing about the manifold absurdities of the censorship regimen maintained so rigorously in the early years by the occupation bureaucracy. The occupation itself could not be criticized. Nor could the atomic bombing of Hiroshima and Nagasaki be mentioned in any publication or performance....

[anne]

http://select.nytimes.com/search/restricted/article?res=F00E13FF34580C748EDDA90994DA404482

October 27, 2002

Lessons From Japan About War's Aftermath
By JOHN W. DOWER

In their immediate response to the shock of Sept. 11, journalists and pundits across America evoked, almost as one, Japan's attack on Pearl Harbor 60 years earlier. Headlines proclaimed a new ''day of infamy.'' Feature stories dwelled on similarities (and differences) between the holy-war fanaticism of the Islamic terrorists and that of the Japanese -- and, of course, on the dismal failure of American intelligence to anticipate either attack.

Now, with the Bush administration itself promoting the virtue of pre-emptive strikes, Japan has emerged as possibly offering a very different sort of historical precedent. Does America's successful occupation of Japan after World War II provide a model for a constructive American role in a post-Saddam Hussein Iraq?

The short answer is no.

By almost all standards, the occupation of defeated Japan was a remarkable success. A repressive and militaristic society emerged from defeat and occupation to become a viable democracy that has posed no threat to its neighbors for half a century. Naysayers who declared the Japanese people to be culturally incapable of self-government -- and their numbers were great in 1945 -- were proved impressively wrong.

Contrary to what self-anointed ''realists'' seem to be suggesting today, however, most of the factors that contributed to the success of nation-building in occupied Japan would be absent in an Iraq militarily defeated by the United States....

[anne]

http://www.bostonreview.net/BR28.1/dower.html

February, 2003

A Warning From History: Don't expect democracy in Iraq.
By John W. Dower

Starting last fall, we began to hear that U.S. policymakers were looking into Japan and Germany after World War II as examples or even models of successful military occupations. In the case of Japan, the imagined analogy with Iraq is probably irresistible. Although Japan was nominally occupied by the victorious "Allied powers" from August 1945 until early 1952, the Americans ran the show and tolerated no disagreement. This was Unilateralism with a capital "U"—much as we are seeing in U.S. global policy in general today. And the occupation was a pronounced success. A repressive society became democratic, and Japan—like Germany—has posed no military threat for over half a century.

The problem is that few if any of the ingredients that made this success possible are present—or would be present—in the case of Iraq. The lessons we can draw from the occupation of Japan all become warnings where Iraq is concerned....

[Sander]

Anne:
You wondered why entrepreneurs wouldnt anticipate inflation by the fed.
You can find an article written about this by austrians here:
http://www.mises.org/story/2673

[christofay]

Anne, i didn't know Dower was that active. I had only heard of the book and thought it was more recent. It sounded like reading it would lead to another reason to keep the head under the covers in the morning and not get out.

[christofay]

Awesome, I feel like a teenager again. Bush will ask for another $50 billion, a surge of spending, for the war in Iraq based on the recent advances. Extra big allowance for the rest of the war to award not flunking out as long as we stay in

Send down my flying car now, and please make it Detroit made

[anne]

http://www.washingtonpost.com/wp-dyn/content/article/2007/08/28/AR2007082801984.html?hpid=topnews

So we understand, we are going to a budget for Iraq * of about $197 billion or $50 billion added to $147 billion. Which means we will be spending more than $16.4 billion a month for the insanely tragic occupation.

We went from $8 billion a month, to $10 to more than $12 and flying above $16.4 billion a month in spending for war and occupation. So much for deciding on guns or butter.

* Already the Administration has put in a completely separate request for about $5.3 billion for more heavily armored vehicles for Iraq.

[anne]

Christofay reminds us of the astounding $200 billion budget coming for the occupation of Iraq. We really do need to consider in depth what this means.

Thank you Sander. I will look to the reference and think carefully.

[anne]

Remember too, the President would use the words of John Downer to support an occupation that Downer warned about from before the beginning. The President would as well use the work of Graham Greene on the American descent to the Vietnam War as a favorable reference to our purpose in Vietnam and our purpose in Iraq. Greene however wrote directly against the tragedy Vietnamese War. History is as of no account.

[shah8]

I read Embracing Defeat a few weeks ago. It was genuinely illuminative, and I recomend it to anyone who wants to learn more about that time and place. I think it's the best book on how the US generally approaches occupations, and strains of this run all the way from the Reconstruction to Vietnam and points later.

And Dower would be right to be pissed with Bush for using his book. One of the primary aspects of that book was on how the Japanese coped with being occupied and how their decisions help make a stable postwar society. There was never a phase like the '45-47 progressive/liberal rule in iraq. There was never a heterogenous occuption membership hashing out a program in Young Republican Iraq. There was never a MacArthur-type (whether he was good or bad for the japanese) individual who headed the occupation for years on end and providing stability. Iraq is simply a complete, utter joke compared to either the japanese or german reconstruction, and Dower is right to be pissed at Bush for putting his name on what's going on in Iraq.

I *do* want to read that awesome Japanese Race War book by Dower as well. Just no ebook version available, legal or otherwise.

[anne]

Shah has again made a most important comment, that I realize is lately echoed by Ben Kiernan at Yale. Though I have never thought in terms of race in looking to conflict or war in Asia, such thought however saddening may help us considerably in understanding.

[anne]

http://query.nytimes.com/gst/fullpage.html?res=9A0DE2D81338F93AA25755C0A960948260

June 19, 1986

Of Bias and War
By HERBERT MITGANG

WAR WITHOUT MERCY
Race and Power in the Pacific War.
By John W. Dower.

FOUR and a half decades after Pearl Harbor, ''War Without Mercy'' is one of the most original and important books to be written about the war between Japan and the United States. More than any official history and beyond any novel written by American or Japanese authors, John W. Dower's book explains how the prejudices and deceptions of racial and national pride - in both countries - were an underlying cause of the Pacific War.

Read today, when the United States and Japan are military allies and trading partners, the ironies abound. No American home is without an appliance containing parts that are made in Japan; no town is without Japanese cars. But look at the caricatures of the late enemy in ''War Without Mercy.'' Even the great British political cartoonist, David Low, put monkey faces on the Japanese and had them swinging from coconut trees. Leatherneck, the Marine monthly, showed pictures of Japanese with louse faces and crawly bodies.

The Japanese, too, lived with illusions and biases against what they considered the soft and inferior Westerners. In a section of the book called ''The War in Japanese Eyes,'' a cartoon from Manga, an official magazine, shows a young Japanese combing ''dandruff'' from her hair - described in the caption as ''extravagance, selfishness, hedonism, liberalism, materialism, money worship, individualism and Anglo-American ideas.'' Japanese cartoonists depicted President Roosevelt and Prime Minister Churchill as half-horse, half-badger, dressed in a costume combining the Almighty Dollar and the piratical skull and crossbones.

Professor Dower, who teaches Japanese Studies at the University of California, San Diego, writes: ''Apart from the genocide of the Jews, racism remains one of the great neglected subjects of World War II.'' The author shows how both the Germans and Japanese, in their propaganda for home consumption, exploited the condition of the blacks in the United States. ''Racism within the Allied camp was, however, a volatile issue in and of itself regardless of what enemy propagandists said. Although only a few individuals spoke up on behalf of the persecuted Japanese-Americans, both the oppression of blacks and the exclusion of Asian immigrants became political issues in wartime America.''

The book's significance goes beyond World War II; it also has meaning for the other two Asian wars that engaged Americans, in Korea and Vietnam....

[anne]

There is work being done at Yale on the aspect of race in the Cambodian tragedy.

http://64.233.169.104/search?q=cache:wa1l4FKNlMcJ:www.yale.edu/gsp/publications/RacialDiscriminationInDK.doc+Racial+Discrimination+in+the+Cambodian+Genocide&hl=en&ct=clnk&cd=1&gl=us

2006

Racial Discrimination in the Cambodian Genocide
By Liai Duong - Yale University

INTRODUCTION

Among the nearly two million people who perished during the Cambodian genocide, were members of Cambodia's ethnic minorities. In other instances of genocide, it is clear that those in power performed horrific acts of racial discrimination against minority groups. During the Holocaust, for example, Nazi antisemitism resulted in the German government's implementation of discriminatory policies, which targeted millions of Jews for execution. In comparison to the Holocaust, it is more difficult to determine whether the Democratic Kampuchea government practiced racially discriminatory policies towards ethnic minorities during the Cambodian Genocide of 1975-79, because of the complexity of delineating what constitutes racial discrimination. Some scholars have disputed the existence of discriminatory policies towards ethnic minorities and have even argued that the ruling Khmer Rouge regime was innocent of genocide. This paper will examine whether the Khmer Rouge implemented racially discriminatory policies towards Cambodia's minority groups. Although Cambodia is composed of many ethnic groups, over 80% of its people are Khmer; only the larger minority groups with the most extensive documentation will be discussed in this paper: the Vietnamese, Chams, and Chinese.

It will be argued that in the experience of all three minority groups, the Khmer Rouge's policies betrayed traces of racial discrimination; however, the severity and type of racial discrimination varied....

[JR]

andyoufalldown:

There is an excellent article published today that exactly addresses your question: http://www.mises.org/story/2673

Basically, how would businesses know if the rate set by the Fed is above or below the natural rate? Maybe consumer time preferences also changed, and maybe not. Market signals are obscured.

Per your second point:
1. The increased investment comes from expanded credit, not from shifting investment from one area to another.

2. Capital goods used for for earlier stage production are different than those used for retail

3. Higher wages caused by higher labor demand will drive up consumer spending assuming time preferences have not changed

4. Lower interest rates will cause people to save less and hence consume more

Remember, however, that with mal-investment caused by artificially lowered interest rates there isn't enough savings to cover the credit / investment as time preferences haven't necessarily changed. So either interest rates are pushed back (thereby putting an end to the boom) or the Fed has to continue to inflate (not good either).

[Craig Tindale]

Inflation is well contained ? Oh I forgot we dont count asset or monetary inflation as inflation, nor do we measure consumer inflation in ways relevant to consumers or the economy .....but yes lets stick our head in the sand and claim inflation is contained because we take as inflations measure the dodgy number that come from government

Here we have $1.4 T mal investment in Real Estate, investment that adds zero productive capacity to the nation , we have mal investment in consumer imports to the point that we fail to generate real wealth or savings as a nation

Monetary policy is causing the kinds of problems the Austrians envisaged they would cause

[Robert]

I am working on rewriting my proof (see URL in my name) of the logical invalidity of Austrian Business Cycle theory. I intend my rewrite to be more terse.

[Craig Tindale]

The problem we have is that lower interest rates causes a re allocation toward "bad credit" away from "good credit" that adds to real wealth.

Bernanke thinks its a valid policy measure (as suggested in his own work) to rain money on the consumer through the real estate asset channel , enact more money rains via money supply financed tax cuts, buy real assets , goods and services , depreciate the currency to cause import price inflation.

He suggested the above in 1999 and here we are now in 2007 and we can see the results.

A blanket acceptance of Austrian theories might be a bit naive for today, but surely we must re visit Schumpeter's ideas, maybe rather than skipping off the down the road with Milton for all these years we should have been more closely following Keynes and Schumpeter.

Keynes always suggested fiscal rather than monetary stimulation, we have had the helicopters overhead for a while now and they casting an Austrian shadow.

The problem is that no ones theories work if the government is unable to undertake credible fiscal management.

All theories aside though if you simply follow the moral thread/cycle of money as outlined by Schumpeter and compare it to our times its not a bad match.

Maybe a decade building condo's and buyin flatscreens isnt the same as manufacturing stuff that other people want, maybe all consumption isnt equal.

[andyoufalldown]

JR --

If the analysis of rational behavior under uncertainty has taught us *anything*, it has taught us that when a signal is masked, guesses about the "true value" of the signal should be symmetric about the signal. So, again that particular aspect of the theory is no better than saying "for no reason in particular, massive capital-oriented malinvestment occurs."

But, like I said in my previous post, that first point is no big deal. You *still* haven't given me any non-frictional reasons why the ABC would predict actual declines in output (rather than to declines in the rate of growth). Your first and second points are non sequiturs; your third and fourth points would only lead to declines in output in an economy that was cycling around its steady-state rate of growth.

[Justin Rietz]

andyoufalldown -

The signal is masked, and even if we accept the idea of symmetry, it would be symmetry around a the artificially low interest rate, would it not?

We also have game theory. If my competitor takes advantage of the interest rate, can I afford not too? I may think that it will cause problems in the long run, but I have to survive in the short run. If I don't offer low mortgage rates, I will lose business - perhaps all of my business.

Finally, as many businesses don't subscribe to the Austrian school, they wouldn't be looking out for this anyway, correct?

I'm not sure what I haven't shown regarding how the bust comes. Remember, the increase in wages caused by increased employment in longer run projects results in consumers buying more - i.e. driving up demand for consumer goods. In addition, with lower interest rates, people save less, and therefore consumer more. So there is no initial bust to support a bust-bust as you describe. We have an all-around boom followed by a bust when the over-investment in longer-term projects / higher order production collapses.

[andyoufalldown]

No, that's the wrong conception of masking. The "signal" provided by the government is prima facie meaningless. Imagine that a friend is trying to send a secret message to you via radio, but he is in the shadow of a much more powerful transmitter, so all you get are golden oldies. Would your guesses about the content of his message be symmetrically distributed about the lyrics to "Surfing USA"?

But once again, to the substance! A fall in national savings only leads to a decline in output per capita when a country has reached it's steady state rate of growth. So that has no busty effects. What about "the collapse" in higher-order/longer-term investments? Well, I will start by reminding you that the ABC is a theory of malinvestment, rather than overinvestment. The various projects that are undertaken may lead to the collapse of the entrepreneurs and investors who controlled the projects, but the fixed capital itself does not collapse (unless it was poorly engineered, har har). Thus there is no particular reason to believe that economic output would decline, even if the people holding the titles to some investments lost them to their debtors when the investments are revalued.

I feel that I have not yet made my (and Krugman's) rather simple point clear to you. The business cycle we observe is boom-bust. The ABC either falls back on the costs of switching resources from one sector to another (in which case it is a bust-bust cycle) or it does not (in which case there is no reason to expect a bust at all). You, meanwhile, seem to believe that you have a very simple theory of how economic output declines in the ABC, which also has not yet become manifest.

[JR]

Your last point first - I definitely do NOT see "my" theory as simple - I am trying to explain ABC theory in a simple manner which is difficult. One of the big hits against ABC theory has been that it is complex in comparison with Keynesian theory. ABC recognizes that every boom-bust is unique and each must be analyzed on its own terms. However, there are common threads.

Our definitions of "masking" are different. From ABC, the idea is that there is no way to know the natural rate with Fed intervention, i.e. the natural rate is masked. Businesses only see that the interest rate is lower and therefore increase investment (for the reasons I stated earlier, but I believe most economic theories hold that lower interest rates increase investment).

I have always said it is mal-investment (this was one of my complaints about Krugman's description of ABC), which is comprised of over-investment in specific longer-term projects.

Why does the implosion create problems? The entrepreneurs and investors you mentioned had to employee people to do the production, right? Many of these employees are laid off or have their wages reduced. Thus, less consumption of consumer goods, leading to a shrinking of retail and consumer goods sectors. Therefore, no new jobs, so we have a general increase in unemployment.

Moreover, if the longer term projects fail, credit taken out by investors / businesses can't be paid back. Financial institutions take a hit. They tighten credit, i.e. higher interest rates, and some fail outright (what we see today among mortgage lenders). This may lead to a further contraction in investment in longer-term projects.

Much of the capital goods produced during the boom are either sold off cheap or are not used at all. During the dot-com boom, what happened to all of the capital (software) produced by startups that failed? Most was never used. Some was bought for pennies on the dollar, but even a large portion of this sits on back room shelfs. The over production of hardware (routers, computers) resulted in the same thing. Basically, the excess capital goods are either only partially utilized or not at all.

Some articles you may find helpful:

"Why don't entrepeneurs outsmart the business cycle?" http://www.mises.org/story/2673

"Austrian theory of the business cycle"
http://www.auburn.edu/~garriro/c6abc.htm

[andyoufalldown]

I apologize for fisking you, JR, but this is the only way to avoid miscommunication.

The entrepreneurs and investors you mentioned had to employee people to do the production, right? Many of these employees are laid off or have their wages reduced. Indeed? In order to understand this claim, we need to agree about what the employees are doing when the entrepreneur loses his shirt. Are they building fixed capital? In this case, they would have had to find new jobs once society had re-optimized its fixed capital stock anyway. Are they producing goods using the fixed capital? Again, Krugman and I claim together that there should be no change in the operation of the enterprise (which relied on price signals), despite the fact that original investment will never be recouped.

Thus, less consumption of consumer goods, leading to a shrinking of retail and consumer goods sectors. Therefore, no new jobs, so we have a general increase in unemployment. I am perfectly willing to accept negative consumption shocks as a cause of recessions. This is the core of mainstream business cycle thinking. But barring an explanation in terms of the money supply, why don't wages adjust to achieve full employment? Likewise with consumer goods; pressure is applied to the price, rather than directly to quantity of goods produced.

Moreover, if the longer term projects fail, credit taken out by investors / businesses can't be paid back. First, the bank normally seizes assets, so most of the losses are absorbed by the investors, which is unfortunate for them but has no economic effects. Second, the possibility of defaults and fire-sales *by itself* can explain nothing. Banks would have no business if they did not take on some amount of risk. Think of the massive sovereign debts that banks wrote off in the 1980s. There, banks weren't even able to seize collateral!

Financial institutions take a hit. They tighten credit, i.e. higher interest rates, and some fail outright (what we see today among mortgage lenders). This may lead to a further contraction in investment in longer-term projects. But again, we need to ask; what is the tightened credit an effect of?

Much of the capital goods produced during the boom are either sold off cheap or are not used at all. ... Basically, the excess capital goods are either only partially utilized or not at all. Remember, unused goods and so forth are the explanandum, so you cannot use evidence of such as your explanans. Goods of sold off cheap, yes; but while this is a loss for the original entrepreneurs, the goods are just as useful as ever, and should be put an equally productive use after the firesale.

Not to be brusque, but ABCT relies on arguments that sound good in a verbal exposition that promises more details later, but cannot be given a logically consistent form. I hope that at the very least I have made it clear to you that Krugman does understand the ABCT, and that he also understands perfectly well that it is malinvestment expressed as sectoral overinvestment that is at issue.

[andyoufalldown]

Oh darn, the italics didn't come out, so it's basically illegible. Sorry about that.

[JR]

andyoufalldown -

I wrote a response, but it is a bit lengthy and probably difficult to read in the comments section here. I'll post it on my blog and provide a link back.