Martin Wolf claims that the Austrian Business Cycle Theory was more nearly correct than mainstream macreconomic theory in explaining the crisis here. Wolf interprets the Austrian theory to be that:
inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash. I have sympathy with this point of view. But Austrians also say - as their predecessors said in the 1930s - that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes.
I have become more and more critical of inflation targeting. I strongly disagree with the claim that fractional reserve banking creates unmanageable credit booms and what I believe is the dominant "free banking" faction of Austrian economists agrees. I do think malinvestments should be liquidated, but favor keeping cash expenditures growing at a slow steady rate during the process. I certainly oppose discretionary fiscal policy as a means of keeping cash expenditures on target. On the other hand, I don't favor raising tax rates to balance the budget in a recession. As for cutting government spending--it depends.
Paul Krugman responded by criticizing the Austrian theory here. He rejects the argument that the unemployment during recessions is due to an unfortunately slow and painful need to liquidate malinvestments and shift labor and other resources to more productive uses. He argues that if that were true, then the boom would also generate symmetrical unemployment as labor and other resources where shifted towards the malinvestments.
Krugman expands upon his argument here. He claims that advocates of the Austrian theory sneak in changes in aggregate demand to explain the lack of symmetry. During the boom, the malinvestments develop in an environment of growing aggregate demand. During the recessions, the malinvestments are liquidated in an environment of shrinking aggregate demand. Krugman argues that it is these changes in aggregate demand that are causing the boom and bust. He claims that the unwillingness of Austrians to develop formal models is what allows them to evade this reality.
Tyler Cowen more or less agrees with Krugman here. Cowen is one of those economists who began as a dogmatic Rothbardian and then over time, came to a more eclectic view. Rothbard's version of the Austrian theory is close to what Wolf described above. Currently, the Mises Institute champions his view.
My macroeconomic views developed in much the same way as Cowen, and like Cowen, I think Krugman has a point. Cowen says that the Austrian theory should not be dismissed but that it should be modified to include insights from Keynesian theory, bubble theory, modern financial theory, and real business cycle theory.
Arnold Kling responds to Krugman here. Kling argues that booms are gradual and busts are sudden. That is why there is little unemployment in the boom and high unemployment in the bust.
I think Kling is correct that a slow change in the composition of demand and the allocation of resources can occur with minimal structural unemployment, while a sudden change will result a large increase in unemployment. On the other hand, I don't see how this fits in with the Austrian theory. Why should money creation create a gradual change in the allocation of resources that must be suddenly reversed?
Peter Boettke comments on the discussion here. Boettke suggests that there are commonalities between some aspects of Keynesian and Austrian theory. He also suggests that the existence of heterogeneous capital goods is an important element of the Austrian theory.
I agree with Krugman that the Austrian Theory of the Business Cycle is a bit unclear and blends together a variety of market processes. Institutional assumptions and judgments about empirical magnitudes are smuggled in by simply focusing on one particular chain of cause and effect. I will illustrate this by giving several different accounts of the Austrian theory.
The first begins with an increase in the quantity of money. The ceteris paribus conditions include a given demand to hold money and an unchanged supply of saving and demand for investment. In other words, the natural interest rate doesn't change. The natural interest rate is the level of "the" interest rate that keeps saving--that part of income not spent on consumer goods and services, equal to investment--spending by firms on capital goods. At the same time, it is the level of "the" interest rate that keeps total spending in the economy equal to the productive capacity of the economy.
Given those ceteris paribus conditions, the increase in the quantity of money immediately results in an excess supply of money. As an institutional assumption, the excess money is lent into existence. Perhaps the central bank lowers the interest rate it charges for loans. Perhaps it purchases short term securities, raising their prices, and lowering their yields. Regardless, the short run effect is a reduction in the market interest rate.
The focus here is on monetary disequilibrium. Because money serves as medium of exchange, people accept it in payment even if they have no intention of increasing their money holdings but rather intend to spend the money. The excess supply of money exists as increased real money balances that people are actually holding, but only because they have yet to spend them.
This increase in both nominal and real balances is matched by an increase in both the nominal and real supply of credit. This is due to the particular institutional assumption, that the money was lent into existence. This increase in the real supply of credit only persists as long as there is an increase in the real quantity of money, matching the excess supply of money.
Because saving supply and investment demand are assumed to be unchanged, and so the natural interest rate is also unchanged, the excess supply of money and increase in the real supply of credit causes the market interest rate to fall below the natural interest rate.
The impact of the lower market interest rate on the composition of demand depends on the interest elasticity of investment demand relative to the interest elasticity of saving supply. If investment demand is more interest elastic than saving supply, then investment rises more than saving falls. Since saving is that part of income not spent on consumer goods and services and investment demand is a demand for capital goods, the demand for capital goods grows more rapidly than the demand for consumer goods.
If the interest elasticity of investment demand and saving supply are equal (though opposite, of course,) then the demand for both capital goods and consumer goods and services grow in proportion.
And finally, if investment demand is less interest elastic that saving supply, then the demand for consumer goods and services grows more rapidly than the demand for capital goods. The impact of monetary disequilibrium--even if the money is lent into existence--depends on relative interest elasticities.
In the traditional Austrian story, this is more or less ignored. At this high level of aggregation, the implicit assumption is that the supply of saving is perfectly inelastic so that the decrease in the market interest rate directly increases only investment demand--spending by firms on capital goods.
Of course, these broad aggregates could be broken down further--durable consumer goods, single family homes, software, commercial structures, equipment--or even down to each and every good or service. There is nothing in theory that prevents the demand for restaurant meals from being more interest elastic than other goods. The lower market interest rate provides less future compensation for sacrificing the utility received from current restaurant meals.
Oddly enough, the typical Austrian story assumes that the immediate expansion in demand is determined by where the "new" money is spent rather than the interest elasticity of the demand for particular goods and services. This is an error.
Consider the following example. Households refrain from going out to eat and purchase bonds. Firms sell bonds to fund the purchase of drill press machines. A central bank appears and makes loans at a lower rate of interest to firms buying drill press machines. All of the "new" money is devoted to the purchase of drill press machines. The firms that borrow from the central bank don't purchase bonds from households. What do the household do with the "old" money that they would have used to purchase bonds from the firms? With the usual assumptions regarding the allocation of consumption over time, the households will use at least some of the "old" money to purchase restaurant meals. While the central bank has made no consumer loans, the households simply use more of their income to buy restaurant meals, save less, and purchase fewer bonds. Only if the supply of saving, and so, the demand for restaurant meals, is perfectly interest inelastic, will the impact of expansion of the quantity of money be limited to the particular place the central bank lent the funds.
The institutional assumption that the new money is lent into existence makes the transformation of an excess supply of money into an increase in the supply of credit plausible. After that point, however, determining which money is "new" and which is "old" and tracing the money is pointless. Interest elasticity becomes the key.
The effect of the increase in demand on relative prices and the composition of output depends on the price elasticities of supply and demand for various goods. In the special case where the supply of saving is perfectly inelastic with respect to the interest rate, while the demand for investment does have the usual negative relationship, then the demand for capital goods rises, and there is no immediate impact on the demand for consumer goods and services. With a normal upward sloping supply curve for capital goods, their prices and quantities both rise in response to the increase in demand. Since the demand for consumer goods and services didn't change, the prices of capital goods have risen relative to consumer goods and the composition of aggregate output shifts towards to production of capital goods. (With scarcity, this should shrink the production of consumer goods.)
More generally, if the demand for both consumer and capital goods rises, because both saving and investment are somewhat interest elastic, then what happens to both relative prices and the quantities of the goods depends on price elasticities of supply and demand of the various goods and services.
Suppose that investment demand is more interest elastic than saving supply, so the demand for capital goods rises more than in proportion to the demand for consumer goods and services. If the supply of both consumer and capital goods are perfectly elastic with respect to price, then the quantities of capital and consumer goods and services with both rise in proportion to the increase in their respective demands. The composition of output would shift with an expansion in the production of capital goods relative to consumer goods. Relative prices remain the same.
Suppose instead that both supply and demand curves have their usual upward and downward sloping shapes respectively, and the elasticities of supply and demand are the same for both consumer goods and services and capital goods. In this rather special case, then with the demand for capital goods rising more than in proportion to the demand consumer goods and services, then the prices of capital goods rise relative to the prices of consumer goods and services and the production of capital goods rises relative to the production of consumer goods and services.
On the other hand, suppose that the supply and demand for consumer goods are highly price inelastic, while the supply and demand for capital goods are highly elastic. Even if the demand for capital goods rises more than in proportion to the demand for consumer goods, it is possible that the prices of consumer goods will rise relative to the prices of capital goods.
The composition of the change in output also depends on price elasticities of supply and demand. Suppose that the demand for capital goods rises more than in proportion to the demand for consumer goods. If the supply of consumer goods are highly price elastic and the supply of capital goods is highly price inelastic, then the prices of capital goods could rise relative to the prices of consumer goods, but the production of consumer goods could expand more than in proposition to the production of capital goods.
Simple supply and demand analysis would be adequate if the impact of a change in the interest rate on the relative prices and quantities of two goods making up a small share of the market were being examined. Implicit in the slopes of the supply and demand curves for those two goods would be all the other goods and services that might be produced or consumed.
However, with a macroeconomic analysis, the fundamental economic principle of scarcity must be included. For example, if all goods are divided between consumer goods and services or capital goods, then an expansion in the production of additional capital goods shifts resources--land, labor and existing capital goods--away from the production of current consumer goods and services. Similarly, an expansion of the current production of consumer goods and services requires a shift of existing resources away from the production of new capital goods.
A special situation consistent with scarcity of resources would be if the supply elasticity of both consumer goods and services and capital goods are perfectly inelastic. If the demand for capital goods is more interest elastic than the demand for consumer goods and services, and the price elasticities of demands are the same, then the lower market interest rate will raise the prices of capital goods relative to consumer goods and enhance the profitability of producing capital goods relative to consumer goods. (This result would be reversed if the price elasticity of demand for consumer goods was sufficiently lower than the price elasticity of demand for capital goods.) Of course, because of the assumption that both supplies are perfectly inelastic, there would be no change in the composition of output or the allocation of existing resources between the production of consumer and capital goods.
Now, suppose these elasticities are only perfectly inelastic in the short run. In the long run, entrepreneurs seek profit by reallocating resources between firms and industries. If profits are enhanced in the capital goods industries relative to consumer goods industries, then more resources must be allocated to capital goods industries, expanding their output and reducing their relative prices and profitability. The other side of the coin is that fewer resources are allocated to consumer goods industries, reducing their production and raising their prices and profitability.
It seems quite reasonable, but it is an illusion. The short run price adjustments will cause the excess supply of money to disappear, and so end the increase in the real supply of credit. The nominal supply of credit doesn't decrease. It is that the nominal supply of loans, augmented by the increase in the nominal quantity of money, no longer can purchase an increased amount of consumer and capital goods at higher prices.
In other words, the analytical short cut of imagining a short run equilibrium set of prices of consumer and capital goods consistent with the lower market interest rate, and then considering some kind of output adjustment that equalizes profitability is mistaken.
Assuming that the elasticities of supply are not perfectly inelastic, then what is really involved is an assumption that a market with a greater shortage can pull resources away from a market with a smaller shortage. This seems plausible enough. If the demand for capital goods is more interest elastic than the demand for consumer goods, and the price elasticities of demand and supply in the markets are the same, then an excess supply of money that is lent into existence will create a greater shortage of capital goods than consumer goods. The production of capital goods expands at the expense of the production of consumer goods. As this occurs, the shortage in consumer goods industries becomes larger and the shortage in capital goods industries becomes smaller because of changes in actual quantities relative to quantities demanded.
Of course, the shortages are simultaneously providing incentives for firms producing and selling both capital and consumer goods to raise their prices. It is this process that ends the "boom" and brings on the "recession." As the prices of both capital and consumer goods rise, the real quantity of money falls. As the real quantity of money falls, so does the real supply of credit. Once the real quantity of money has fallen enough so that it has returned to level of real money balances people want to hold, then the real supply of credit is no longer enhanced by the excess supply of money. The real supply of credit has returned to its initial level. The market interest rate, no longer clearing this additional real supply of credit, rises back to the natural interest rate.
If the economy really remains at full employment during this process, then the production of consumer goods decreases in the "boom" even though growing demand has led to shortages of consumer goods. As the economy goes into the recession phase, the production of consumer goods must rise and the production of capital goods must fall.
Because the higher price level reduces the excess supply of money, reduces the real supply of credit, and raises the market interest rate, it is natural to assume that demands for consumer and capital goods fall. And so, the lower demand result in less production and employment. In other words, a recession.
But this is an illusion. The higher market interest rates does reduce demand, but there are shortages, and so the reduction in demand is bringing demand back down to what can actually be produced. The higher interest rates are closing the shortages. While the shortages of the more interest elastic goods close faster (again, assuming equal price elasticities of supply and demand,) the result will be that the shortages for the less interest elastic goods become larger relative to those of the more interest elastic goods. The "recession" phase then should occur in the context of shortages of both capital goods and consumer goods and services, with the production of consumer goods and services expanding through this process of markets with greater shortages pulling resources away from markets with smaller shortages.
Clearly, it would be possible that this process could leave the markets for highly interest elastic goods in surplus. But it isn't necessary that this would occur. And if it did occur, the prices of capital goods, for example, have "overshot," their long run level. However, even if that is true, there remain shortages of consumer goods and services.
Of course, the issue of "overshooting" brings the question of expectations to the fore. The rational expectations equilibrium is for prices to be set to clear these markets. Which would mean that the prices of both consumer goods and capital goods rise in proportion immediately. The real quantity of money remains unchanged at the amount people want to hold. The real supply of credit remains unchanged--the expanded nominal supply of credit purchases the same amount of consumer and capital goods. The market interest rate remains unchanged at the natural interest rate. The production of consumer and capital goods are unaffected.
Returning to Krugman's critique and Kling's response, it seems that this entire disequilibrium process could from beginning to end be associated with somewhat higher structural unemployment. However, in the context of a growing economy, it is difficult to see why having larger shortages in more interest elastic industries and then in less interest elastic industries (again, keeping in mind that price elasticities of demand and supply must be taken into account,) would do little more than causes shifts in which sectors of the economy hire new entrants. It is hard to see how this disequilibrium process could require that highly interest elastic industries absolutely shrink in size, and lay off workers.
Now, if the "tight" full employment assumption is relaxed, so that more capital and consumer goods can be produced when the demand for both rise, then aggregate output rises, and it plausibly rises more in industries with more interest elastic demand As the economy "contracts," then the contraction would be concentrated in those same industries.
Further, if the source of the monetary disequilibrium is not a single increase in the quantity of money, but rather growing quantity of money, the expansion in output could be more presistent. The growing nominal quantity of money generates a growing exess supply of money and a growing real supply of credit. This should be associated with a falling market interest rate and growing shortages of goods with high interest elasticities of demand.
Of course, the rational expectations equilibrium is for the prices of consumer goods and capital goods to immediately begin rising in proportion. The real quantity of money remains the same. The real supply of credit remains the same, even while the nominal supply of credit grows, though able to only purchase unchanged amounts of consumer and capital goods. The market interest rate is unaffected as is the production of consumer and capital goods.
My judgement has always been that this disequilibrium process, especially if there is a "tight" assumption of full employment, is an implausible explanation of recession. Perhaps an excess supply of money, even caused by an acceleration of money growth, might cause a boom that is somewhat imbalanced, but the return to equilibrium will simply be somewhat slower growth in output, especially in those highly interest elastic sectors. A disequilibrium expansion, particularly in some sectors, and then a return to monetary equilibrium is possible, it is just difficult to see how it would be significant.
In my judgement, a much more plausible avenue for a recession would be the opposite sort of monetary disequilibrium, an excess demand for money. If some minimal disruption of production associated with a return to monetary equilibrium triggers a decrease in the quantity of money or an increase in the demand to hold money, then falling cash expenditures on both consumer goods and services and capital goods could result in falling production and employment throughout the economy. As Krugman suggested, the problem would be falling aggregate demand.
Are there other market processes associated with money creation that could result in more significant malinvestment? My next foray into the Austrian Business Cycle Theory will explore an "equilibrium" process that impacts the composition of output.
Bill,
ReplyDeleteThere's a lot of meat there. Very interesting, as usual.
When you say that the bust should really just be a slowdown in growth in the Austrian theory, if you ran the output through a Hodrick-Prescott filter, growth need not necessarily be negative, but it would be below potential. You would still see a familiar pattern of the business cycle. For instance, residential investment was correcting sharply even before the recession started in December 2007 and there was no broad recession. Further, GDP wasn't even declining that sharply until the financial crisis hit in Q3 2008. Similarly with China, you could say there are Austrian booms/busts without necessarily seeing negative growth rates QoQ since their potential growth is so high. It depends a lot of the structure of the economy and the size of the imbalances relative to the rest of the economy.
Further, I don't think most adherents to the Austrian theory would argue it's the only theory of recessions or that it's the most general theory of the business cycle. There's no reason there won't be other things going on, like changing demand to hold money. Unfortunately, it's difficult to assess the relative significance of the two. For instance, people typically increase their demand to hold money during periods of financial instability. But what caused the financial instability. What if there's a slowdown of growth perpetuated by some sort of financial accelerator mechanism, creating some instability/uncertainty that ultimately led to people increasing their desire to hold money. My view is that sometimes the Austrian story can help explain some slowdowns in growth and some of these other stories can help you explain the depth of recessions.
I don't think Krugman is correct.
ReplyDeleteYou don't need aggregate demand for it to work, you can do it completely from the supply side.
You don't even need it to be an aggregate, it can be just a few industries.
A good example is housing in the recent boom/bust, there wasn't a national housing bubble, just local ones, but the ABC effects combined with bank leverage meant that we had a banking crash/panic.
I'm in agreement with Doc Merlin here. Krugman may have a point, but it isn't a very sharp one. Tyler, often a bit cryptic for my taste, may be on to something though. Austrian theory alone doesn't necessarily explain everything at all times, and it is healthy to consider other models. This is more an indictment of dogmatic thinking and over use of single models to explain the world than the ABCT itself though.
ReplyDeleteBill: I was reading through, saying to myself "But Bill...but Bill....". And then halfway down I read your:
ReplyDelete"It seems quite reasonable, but it is an illusion. The short run price adjustments will cause the excess supply of money to disappear, and so end the increase in the real supply of credit."
Yep!
In other words, either Austrians assume perfectly flexible prices, or they don't.
If they do assume perfectly flexible prices, then prices immediately rise to restore the real money supply to its original level. Game over.
And if they don't, and instead assume sticky prices, then we are back in the world of standard Keynesian/Monetarist theories. And if we want to disaggregate, then what happens depends on interest- and other demand elasticities, as you say, but also on which prices adjust more quickly. We get different results if capital or consumer goods prices adjust more quickly.
Also, and this is I think the big contribution of New Keynesian macro, we need to replace perfect with imperfect competition if we are to explain why (with sticky prices) firms respond to an increased demand by increasing output, rather than just rationing customers. Because under perfect competition in all markets, and fixed prices, an increased supply of money just causes an excess demand, but no increase in actual output or sales.
Nick:
ReplyDeleteYour post about imperfect competition--especially monopolistic competition--was excellent regarding how more rapid growth of expenditure can create a boom.
It's not a matter of perfectly flexible versus sticky prices. It is a matter of the time it takes for new money to work its way through the economy. The significance of where the money first appears is no error. Whoever gets it first will enjoy its full spending power. Furthermore, there is no reason to assume merely a shift in the nature of borrowing, from selling bonds to households to getting money from the central bank. The injection of money will result in MORE money being borrowed to finance capital projects, more than would be indicated by free market interest rates, and thus likely more than is sustainable at profit.
ReplyDeleteKrugman's claim, that the boom would generate unemployment for the same reasons as the bust, is easily dismissed. During the boom, employees with jobs are hired away by other employers. There is no need for them to sit around idle and wait for an opening. During the bust, people are laid off and have to wait for restructuring to open up new jobs.
John:
ReplyDeleteThank you for your comments.
I realize that Selgin, White, Horwitz, and Garrison (and presumably more) as well as Hayek and maybe even Mises, often emphasize the secondary deflation/depression.
My view is that the sort of disequilibrium process I tried to describe above is unlikely to generate much malinvestment. If the liquidation of these malinvestments triggers a significant excess demand for money, I think the problem is in the fragility of the monetary institutions.
I think Tyler is right about integrating bubble theory, real business cycle theory, and the like. And some "Austrian" macreconomists are doing that. Horwitz, for example, has added some bubble theory into the standard account, along with the secondary depression/deflation.
Bill,
ReplyDeleteThere are more problems in what you have written above than I can explain in a brief time. I would recommend that you re-familiarise yourself with the ABCT, because if this post is anything to go by you don't understand it.
Firstly, yes, there is an assumption that money is injected into the loan market first. Mises points this out somewhere noting that if a certain amount of fiat money were simply given to each citizen then the result wouldn't be ABCT, though there would be distortions.
Secondly, in the medium term investment is always scarce, like labour. The supply-demand analysis of the savings-investment market only applies in the very short term.
Thirdly, you don't understand the Cantillon effect. The Cantillon effect isn't about the interest elasticity of industries, it is about accounting and profit. If money is injected in some place in the economy then it leads to higher profits in that area which gradually spread away from the injection point.
Current,
ReplyDeleteIf I understand Woolsey correctly, then I believe the Cantillon effect is offset, because lower interest rates increase spending on consumption. Although areas where new money is injected record high profits, other areas simultaneously record greater profits as spending increases.
In other words, whether the Cantillon effects matter (as though I actually know what that means) depends on the means by which new money is injected into the system.
As I said on Coordination Problem what is the chance that the one effect exactly offsets the other?
ReplyDeleteMises says somewhere that if the money stock were increased across the board for all agents then there would not be ABCT. This is the same as Hume's thought experiment where everyone wakes up richer one day. But, this isn't what happens.
Money is first lent and normally lent out to finance investment. The expectations that this investment will produces future wealth will cause the investors to increase their consumption too. However, how can that happen to exactly the same extent? Also, the investment will be in more roundabout processes of production than are currently in use. As Garrison points out this leads to a "broken-backed" capital triangle.
Thanks Bill!
ReplyDeleteA thought-experiment in 2 stages:
1. Double everyone's stock of money and double all prices.
2. Now redistribute the existing stock of money.
1+2=Cantillon effects.
1 is neutral, as we know. Therefore 2=real Cantillon effects. What are the real effects of 2 on output and employment?
Current and Allan:
ReplyDeleteThank you for your comments.
I think you are both very much wrong about the focus on tracing new money.
It is not like I have never heard of this before. I said that is the focus of much Austrian discussion. I am saying it is wrong headed!
What is important is the new pattern of demands created by the disequilibrium prices.
Think again about my story. Perhaps I wasn't clear enough.
Of course, it is likely that households will continue to purchase some bonds, and that firms will continue to fund some drill press machines by bond sales. The firms buy less drill press machines funded by bonds, but more altogether because they are funding some by borrowing new money from the central bank.
But while the households are likely to continue to purchase some bonds that will be used to fund some drill press machines, they are likely to buy fewer bonds and instead use more income to purchase restaurant meals. The lower interest rate causes an incentive to save less and consume more. The lower interest rate creates an incentive for them to purchase restaurant meals.
The lower interest rate causes a change in the way "old money" is spent. It causes a change in the pattern of demands.
As for the drill press machines, there is no reason to distinguish between the ones purchased with new money from the central bank and the ones purchased with old money from bond sales.
What is important is that some of the drill presses are only profitable because of the lower interest rate. It is those that are the malinvestments, not the ones that happened to be purchased with money from the central bank.
And, of course, the added demand for restaurant meals is a distortion created by the central bank's expansion of the quantity of money, even though no "new" money is spent on them.
That the money was lent into existence is relevant. And that is it. It is the distorted pattern of demands that has the impact, regardless of whether new or old money is being spent.
I will write a post on this subject specifically.
Bill, Nice post. I tend to agree with you, and also with Nick's comments. Regarding Nick's last question, I've always assumed the Cantillon effects had to work through some mechanism beyond simply redistributing money. The size of the monetary base injections during booms is typically quite small relative to GDP. Redistributing that money would not produce important macro effects. To be honest, I've never understood what the Cantillon effect is supposed to be all about. The Fed typically buys Treasury securities. Whoever gets the money would typically buy some other asset. But the amounts are so small that the impact on other asset markets would usually be tiny. Yes, recent Fed OMOs have had a big effect on the mortgage bond market. But the Cantillon effect is an old idea, so I presume people thought it was important even back when changes in the monetary base over the business cycle were tiny.
ReplyDeleteIf that was confusing, here's another way of thinking about it. When the Fed does an OMO one asset is swapped for another asset of roughly equal value. One meaning of "redistribution" is Nordic-style egalitarianism--where wealth is redistributed. Monetary policy doesn't do that directly, although obviously it can indirectly influence asset prices. So I assume Nick's step 2 is actually "now swap money and T-bonds in such a way that no one's net wealth is changed." Would that have any effect? No, people would simply reverse the action as soon as they were allowed to trade.
Allan:
ReplyDeleteWhy doesn't a bust involve firms producing consumer goods hiring employees away from firms producing capital goods?
Current:
ReplyDeleteYou say that investment is aways scarce in the medium term. And that the supply-demand analysis of saving-investment only applies in the very short run.
I am pretty sure that whatever runs the supply-demand analysis of saving-investment applies to, it is consistent with scarcity.
Of course, I don't know what you mean when you say, "investment is always scarce in the medium run."
I kind of go with the notion that everything is scarce in all runs. But I am puzzled by what you mean by investment.
Nick:
ReplyDeleteI will think about it. But I would think the impact of the composition of demand and output depends on what the poorer people choose to give up and what the richer people choose to buy.
Bill: That's my take on it too. And like Scott, I don't think the magnitude of the effects are big enough to really matter. (Unless we are talking about Zimbabwe-magnitude money creation, where clearly Mugabe's preferences got satisfied by the seigniorage at the expense of other Zimbabwean's preferences, which got curtailed by the inflation tax.)
ReplyDelete"Allan:
ReplyDeleteWhy doesn't a bust involve firms producing consumer goods hiring employees away from firms producing capital goods?"
I can't imagine why it would. When unsustainable capital projects fail, how does that cause consumer goods firms suddenly to want to hire more workers, just in time to suck them out of capital goods firms before they get laid off?
Also, whatever are the unsustainable capital projects that may be stimulated by an injection of money, be they investments in capital goods industries or consumer goods industries, they will cause dislocation when they fail. The reason why capital goods industries may be the bigger problem is that the longer the time to fruition in final consumer goods, the greater must be the sensitivity to changes in interest rates.
I try to think in terms of the information that would be transmitted by prices, including interest rates, and what happens if the information is distorted. A low interest rate would correspond to ample savings available to be allocated to long-term projects that take time to come to fruition. If monetary injection lowers interest rates to falsely indicate ample savings, the stimulative effect should be greatest on longer-term, higher-order projects.
Strigl's Capital & Production made clear that capital investment requires what amounts to a "subsistence fund" of savings, and the more roundabout the capital project, the larger the fund required.
Ex-Rothbardians attack a simple Rothbardian strawman -- and then pretend they've engaged Hayek.
ReplyDeleteThis is a form of intellectual malpractice.
Allan:
ReplyDeleteWhat is this "saving fund" Strigl describes? What is it exactly? Money? Capital goods? Consumer goods?
You say that these long term projects cannot be sustained? Why not? What exactly isn't available to sustain them?
One of Mises' arguments is that in order to maintain the malinvestments it is necessary to accelerate inflation. This leads to a crack up boom--hyperinflation and the end of the monetary economy. Suppose that doesn't occur. Suppose inflation is just maintained, and the malinvestments liquidate in the context of stable money growth. Think about it. How exactly does that work out?
I hope you can see that all of my questions above point in the same direction.
What is this saving fund? It is consumer goods that people want now. If there is not enough of them, then that implies a demand for consumer goods and employment opportunities in producing consumer goods.
Why can't the long term projects be sustained? The resources necessary are more valuable if used to produce consumer goods. That means a higher demand for consumer goods and opportunities to produce consumer goods.
If inflation is maintained and not accelerated, the growing demand for consumer goods strips resources away from the production of capital goods. That is why they cannot be maintained. But this implies increased employment opportunities for producing consumer goods.
Nick:
ReplyDeleteSoon I will discuss the inflation tax. I think that is an equilibrium process that obviously impacts the allocation of resources. And, I don't see why it can't be earmarked to a subsidy on making loans. Perhaps standard central bank policy doesn't have that effect, but I think it is possible.
Nick:
ReplyDeleteI think that the Austrian Theory of the Business Cycle confounds the disequilibrium process described above with an inflation tax argument.
I think the entire problem that's being run into here is that everyone seems to be refusing to engage with the huge differences in Austrian capital theory, differences not shared by the gdse-derived box that the ABCT is trying to be fit into. The ABCT can only really be well understood through the lens of this capital theory. I mean, to give an example of why, here's something that really just caught my eye immediately from Bill's blog post:
ReplyDelete"Why should money creation create a gradual change in the allocation of resources that must be suddenly reversed?"
In the capital theory lain out by Bohm-Bawerk, there's a more to how capital effects the economy than just shifts in a 'k' variable. Capital has a more definite structure with extension across space and time, where a tree is cut down in Cascadia and goes through a whole host of modifications by intermediaries before finding its wood in the paneling of a nice German luxury car. Attention to how scarce resources are moved about on this chain of processes (cutting down more trees and cutting back on actual car output), how resources are moved about between chains, and a whole host of other factors come into play when there's some heft to your capital theory. It depends heavily on ideas of price elasticity, and yet a whole section of Woolsey's critique deals with how Austrians are ignoring price elasticity.
There really are many excellent, modern expositions on Austrian theory which go deep into the details of how it works, which really aren't that long. The one I like to link to ( http://www.auburn.edu/~garriro/cbm.htm ) is only a dozen or two pages of material, written in rather clear language that any trained economist should easily under and any student could get used to pretty quickly. If you really, really want to critique something, please, understand it as best as possible so the criticism can be constructive.
There's been so much done with it all in the last thirty years, it's a waste to have the public discussion of Austrian theory be based on this second- or third-hand account of it. It can't be fit into any of the other existing theories because, to some extent, the capital theory the business cycle theory is based on is general enough that it can explain most of the same things that other theories look at. Yeah, if you put the Austrian theory in Keynesian terms, it would look awful Keynesian, but only because they're really talking about the same thing.
Much, much more attention needs to be payed to the real contributions of Austrian economists beyond Mises and Hayek. While every tradition has its masters, they're rarely the sole positive contributors.
Michael M:
ReplyDeleteI have read Garrison's presentation.
One response to the Austrian theory was that the increase in investment leads to increase in the capital stock. The increase in the capital allows for an increase in the production of consumer goods and services. And so, there is no shortage of consumer goods by the time the new money reaches workers. There is no problem of their being inadequate resources to produce the consumer goods they want as well as the capital goods.
The Austrian response to this argument has been that capital is this complicated structure, etc.
I don't disagree with this response. While I think it is unlikely that the capital goods produced are generally valueless, they are worth less than their opportunity costs. There is waste in the scenario.
I am inclined to the "Keyneisan diversion" view of Keynes. That changes in aggregate expenditure will result in changes in aggregate output is a pre-Keynesian idea. Krugman, on the other hand, insists that it is Keynesian.
Anyway, Garrison includes what I (and he) would call the pre-Keynesian idea that changes in aggregate expenditure lead to changes in aggregate output. Garrison, of course, integrates this with malinvestment stories.
As I explained in my post, I don't believe the malinvestment that comes from changes in the interest rate caused by an excess supply of money are likely to be significant.
It isn't hard to modify my presentation and add intermediate goods or that part of gross investment used to offset depreciation. If there is an excess supply of money, there are fundamentally shortages of everything, and the return to equilibrium, including market interest rates, is closing off shortages, not creating surpluses.
Michael M.:
ReplyDeleteThank you for that citation. I said I had read it, but I just read it. While there was nothing especially new to me, I don't think I had seen it.
I find nothing remarkable in the analysis of saving and investment there. While my background goes from Austrian to an eclectic adoption of neo-classical approaches, I think that much of what Garrison wrote is just standard. I am sure that "Keynesians" would mostly agree that increased saving allows for increased production and consumption in the long run. While Hayek triangles are very unusual, most economists are aware of the present value formula and the implications for present value of returns in the distant future.
Aside from the straw man treatment of Keynesians, there are some things that I find a bit irritating about Garrison's exposition here.
I am afraid I saw nothing about price elasticities of demand or supply. I could see some hints about it, of course. The size of the price changes needed to cause shifts between stages of production.
I am not at all persuaded that the demand for replacement capital goods rises less than other goods. I am not sure why they would be identified with "middle stages," since some of them might be quite durable. As for actual "middle stages," it would seem to me that their demands rise both because of the lower discount rate and increased derived demand.
Anyway, I see nothing in Garrison that was inconsistent with what I wrote.
Anonymous:
ReplyDeleteYou sure write like Greg Ransom!
My view is that there are many versions of the Austrian theory. Rothbard's version is one of them. I am not sure whether you are claiming that I created a strawman of Rothbard's version and then pretended that I have shown everything Hayek said was worthless. Or, if pointing out errors in Rothbard's version amounts to attacking a strawman since it is absurdly simplistic in comparison of Hayek's approach.
What did you mean?
"What is this "saving fund" Strigl describes?"
ReplyDeleteIt has been a couple of years since I read the book, but as I recall Strigl demands that we look at the underlying physical reality. Changes in the quantity of fiat money do indeed have effects, but they cannot abolish scarcity and what follows from it. I'll address it my way.
Crusoe, as often, can clarify. His ability to embark on a roundabout production method, i.e., to make a capital investment, depends on a store of provisions (which counts as capital, which he is investing to create new capital) to tide him over while he diverts his efforts to that project. If he embarks on a project that takes too long, he will run out of provisions. Then he will be worse off than before, because not only will he lack the new, hopefully more productive method, he will have squandered his provisions and must go back to accumulating a store thereof via his old methods. If his project involved restructuring his old capital (say, dismantling a small fishing net to serve as part of a much larger one under construction, or moving his goods to another part of the island), he can be much worse off indeed (because he may even have to regress to fishing by hand until he can rebuild his old small net, or move everything back.) Or, if the store of provisions has been reduced far enough, it may not even tide him over sufficiently to repair and replace simpler tools on a timely basis. He is reduced to living with a less productive capital structure than before. Crusoe himself may be whistling a merry tune all the while that he is working on the new project, right up to the moment he discovers his error. Then things will suddenly look different.
These considerations illuminate the importance of the capital structure and attempted modifications thereto (not merely a quantity of undifferentiated "k", as Michael M. points out). Neither fiat money injections nor long disquisitions on elasticities nor the highly complicated nature of the modern economy can change the physical reality that the ability to expand capital itself depends on pre-existing, real physical savings of consumer goods (which become capital goods when serving the goal of enabling the allocation to resources to capital formation) and conventional capital goods. Whatever stimulates a sufficiently large-scale version of Crusoe's miscalculation will have an analogous effect. Capital will have been squandered, restructuring will be required which may result temporarily in a lower level of output than the pre-existing baseline.
Crusoe's economy is simple enough for him to judge directly what projects are feasible and what are not. In the market economy, prices, including interest, play the essential informative role. Monetary injections distort those prices and falsify the information, leading to potentially disastrous error. It is the distortion of the structure of production that does the damage. Easy money makes higher-order capital and increased roundaboutness look better relative to lower-order capital, and it makes capital-intensive production methods look better relative to labor-intensive. Thereby it moves the structure away from what is sustainable and profitable, as would be indicated by undisturbed market prices and interest rates.
I recognize the challenge to trace all this through in terms of the actual effects of monetary manipulation on interest rates and prices and how these play out. If I may be so bold, however, I would assert that the above realities cannot be evaded. If one's economic toolkit does not reflect those realities, then it needs to be re-examined.
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ReplyDeleteAllan:
ReplyDeleteThanks for the explanation.
Crusoe works 8 hour days. To construct a net, he works 9 hour days. He sacrifices an hour of leisure each day.
Crusoe easily collects enough coconuts to survive in an hour each day. He spends the rest of the day gathering berries and catching fish for variety.
He continues to work 8 hours and spends only 5 hours on fish and berries. It is enough to maintain health, but he has to eat more coconuts than he would prefer. He spends 2 hours gathering coconuts. He spends one hour on the net.
It is possible that producing the net will take longer than anticipated. Even if it is all he dreamed of in terms of fish catching ability, he may regret all of the fish and berries he gave up during the time it took him to construct it.
Of course, the net might not work out as well as he thought. He might regret that too. He might not get as many fish as expected even if it is completed on time.
Anyway, I think that the real world is much closer to my story than the notion that Crusoe first stored up some coconuts and then started working full time building the net, and the net wasn't complete by the time he ran out of coconuts.
But suppose he did what you said. When he runs out of coconuts, he starts gathering them again. How is he unemployed? There is a shortage of coconuts, so he deploys more labor to gather them. He might continue to work on the net part time.
If you read my original post, no part of it suggests that monetary disequilibrium allows for a permanent increase in real income. My point is rather that it has little impact on the allocation or resources at all.
Bill, I'm trying to address one question at a time, within the limited time I have right now. You asked about Strigl's subsistence fund and how it relates to unsustainability of long-term capital projects. I gave an answer to that. As Crusoe's miscalculation of his subsistence fund forces him to break off his ambitious capital project, so it is in the modern economy that capital projects require a store of previous capital and this limitation cannot be overcome simply because the Fed pumps in more cash.
ReplyDeleteTrue, at the lowest order, Crusoe may be able to continue working on the net part-time. But if, as I noted, his project involved a restructuring of productive capital, such as dismantling his smaller net or moving his goods to a distant location, then he is reduced to a lower standard of living because he now has to survive and save without immediate access to even the more modest capital that he had intended to replace. In other words, the error has pushed him back down the hierarchy of capital to the less roundabout and more primitive. In the modern economy, it's just a more elaborate version of the same story. Capital investments remove real resources from some uses--i.e., from some parts of the structure of production--and tie them up in other projects. If those projects fail because we cannot continue to divert sufficient resources from other uses to finish them, the capital that was diverted is not readily available to its previous uses either. So I believe we have an understanding of how capital projects stimulated by easy money can be unsustainable and how their failure can leave the economy worse off even than the previous baseline.
Crusoe's mistake doesn't leave him unemployed, of course--except that he will probably have to sit down for awhile and make a new plan, what to do first, how to salvage what he can. The analogous process in the modern economy involves restructuring large segments of an ecologically complex structure of production, through transactions that are informed by (and inform) changing prices. Suppose we considered an intermediate case, in which a crew of workers is building a house and gets half done when it is discovered that there are insufficient materials to complete it according to the original specs. I bet you the first thing that happens is all the workers are sent home until there is a plan for partially tearing the structure down and completing a smaller version. When the project was originally begun, the workers might have been hired away from other jobs with no break in employment. But finding a new job when you've lost one takes time, and if the same mistake has been made at many building sites, then it may take a lot of time.
ReplyDeleteYou also asked: "One of Mises' arguments is that in order to maintain the malinvestments it is necessary to accelerate inflation. This leads to a crack up boom--hyperinflation and the end of the monetary economy. Suppose that doesn't occur. Suppose inflation is just maintained, and the malinvestments liquidate in the context of stable money growth. Think about it. How exactly does that work out?"
May I take it that you are conceding Mises' point that malinvestments induced by inflation cannot be maintained? Then the question of how disruptive their failure may be depends at least in part on how long and hard the original inflationary policy was pushed. If you quickly settle down to a constant rate of inflation that everyone can count on and allow for over a long time period, then it probably would not be disruptive. That whole idea of course depends on pols and bureaucrats' self-restraint.
"If inflation is maintained and not accelerated, the growing demand for consumer goods strips resources away from the production of capital goods. That is why they cannot be maintained. But this implies increased employment opportunities for producing consumer goods."
Yes, if the disruption of the structure of production is not too great. After all, there are lots of malinvestments all the time due to entrepreneurial errors. These get liquidated and people find new employment. The more freely that wages and prices can adjust, the smoother the changes can be. But large-scale, systematic distortions that run deep into the structure of production are different. The total quantity and relative quantities of different consumer goods themselves depend on the capital structure. If too much capital has been diverted to higher-order projects or to the wrong mix of consumer goods, then the situation is not so simple as a smooth shift of labor from capital goods industries to consumer goods industries. And, heaven help us, if monetary and fiscal meddling in the market has left a great deal of uncertainty about the future, then it may inhibit the very entrepreneurship that is necessary to bring about needed restructuring.
Allan:
ReplyDeleteThe notion that a long inflation results in large malinvestments is false.
I don't think it makes any sense.
While the nominal quantity of money and the nominal supply of credit may have increased a lot, the real supply of credit and the real supply of money won't have increased hardly at all. And it is the real changes that might create malinvestment.
P.S. I don't think firms quit producing houses because they ran out of nails. They quit producing houses because they couldn't sell them at a price that would cover the costs of the additional nails.
Where is the evidence that recessions are associated with shortages of consumer goods? If there were such shortages, why don't workers smoothly get hired to produce the consumer goods? What you are saying is the the long term pojects fail because resources, like labor, get pulled away from the long term projects.
"The notion that a long inflation results in large malinvestments is false."
ReplyDeleteAre you using "inflation" to mean an increase in prices or an increase in the supply of money? By easy money I mean something more like the latter. Would you deny that easy money had anything to do with the recent housing bubble and bust? Or with the stock price bubble that led up to the 1929 crash? Or with the speculative land boom of the 1920s? Do you deny that if monetary injection depresses interest rates it makes long-term capital projects appear more viable? Do you deny that monetary injections cannot make real savings and real resources appear out of thin air? Do you deny therefore that monetary injections, by making capital projects appear viable that aren't, can produce malinvestment? If so, then I believe we have reached an impasse.
"And it is the real changes that might create malinvestment."
Huh? Real increases in savings, available for borrowing, and lower interest rates that reflect a decreased time preference and longer time horizon on the part of the saving public, are the stuff of good, wealth-building capital investment.
"Where is the evidence that recessions are associated with shortages of consumer goods?"
By definition a recession is a decrease in output. People are not getting all the stuff they would like or this would not be a topic of discussion. What are you actually asking me?
"If there were such shortages, why don't workers smoothly get hired to produce the consumer goods?"
In general I think the reallocation of labor and resumption of production can be fairly quick and smooth if prices and wages can adjust freely, if monetary intervention stops so that clarity can be reached, and if the political climate does not introduce further uncertainty or penalize profit.
"What you are saying is the the long term projects fail because resources, like labor, get pulled away from the long term projects."
What I'm saying is just what you said about houses in the previous paragraph: Long term projects fail when it becomes clear that they cannot be brought profitably to fruition.
Allan:
ReplyDeleteI do deny that "easy money" was a significant cause of the malinvestment in housing during the last decade. I am not at all convinced that there actually was real malinvestment associated with the stock market boom in the twenties. I don't really know much about real estate speculation in the twenties.
Nowhere will you find me arguing that "easy money" creates wealth in a persistent way.
I generally use the term "inflation" to refer to a rising price level over time. However, what is relevant regarding possible malinvestment is monetary disequlibrium, and neither persistent nominal money growth or persistent price inflation is relevant.
A surplus of money exists when the real money supply is greater than the demand to hold purchasing power in the form of money. It is, in fact, the usual state of the world to have money and prices both growing together, and at each point in time, the real quantity of money to remain equal to the real demand to hold money.
It is, of course, possible for the nominal quantity of money to grow faster than prices, so that the real quantity of money grows. It is possible that the real quantity of money might grow faster than the demand to hold real money balances. This creates a real surplus of money. With plausible monetary institutions, that creates a matching increase in the real supply of credit. That should lower market interest rates. It is unlikely that this will impact the demands for all goods and services in exact proportion.
But once the price level catches up so that the real quantity of money matches the real demand for money, and prices and real money demand are equal and growing together, there is no longer a real surplus of money, no additional real supply of credit, and now downward impact on market interest rates--at least through this avenue.
The nominal quantity of money and prices could both rise for decades without there being any further malinvestment from this source. Any malinvestment that existed has to be liquidated even as money and prices rise.
The nominal quantity of credit would be rising too. The nominal interest rate is actually higher in such an equilibrium, though the real interest rate is back to equilibrium.
Nowhere in this argument is a claim that there is a permanently higher capital stock and higher levels of consumption, and permanently lower real interest rates, or permanently higher real wages.
To the degree there is some kind of change in the composition of output during the adjustment to the new inflationary equilibrium, that is a bad thing (I think.)
And I don't see there being much good from moving to new inflationary equilibrium!
"The nominal quantity of money and prices could both rise for decades without there being any further malinvestment from this source. Any malinvestment that existed has to be liquidated even as money and prices rise."
ReplyDeleteI don't think this is inconsistent with Mises' statement that an increasing rate of monetary expansion is necessary to prevent liquidation of the malinvestment created by the initial monetary bump-up. If the rate of increase then remains constant over a long time so that people can adjust to it, then I don't see it being disruptive. The big question is whether pols and bureaucrats could be counted on to exercise such self-restraint. (When you think about it, it's not really a question.)
Thank you for the discussion and the opportunity to explore and test my understanding of ABCT. The questions were helpful. I admit to not having definitive answers for all.
I think Allan did a great job of explaining the ABCT position. I just wish he didn't give in (maybe he just didn't want to bother arguing such an obvious point) to the ridiculous argument that monetary creation and price increases can reach a steady state if they move in unison. What on earth makes you think that steady price increases can happen across an entire economy and that distortions wont beget further distortions?
ReplyDeleteI'll start by pointing out some of your oversimplifications:
"Consider the following example. Households refrain from going out to eat and purchase bonds. Firms sell bonds to fund the purchase of drill press machines. A central bank appears and makes loans at a lower rate of interest to firms buying drill press machines. All of the "new" money is devoted to the purchase of drill press machines. The firms that borrow from the central bank don't purchase bonds from households. What do the household do with the "old" money that they would have used to purchase bonds from the firms? With the usual assumptions regarding the allocation of consumption over time, the households will use at least some of the "old" money to purchase restaurant meals. While the central bank has made no consumer loans, the households simply use more of their income to buy restaurant meals, save less, and purchase fewer bonds. Only if the supply of saving, and so, the demand for restaurant meals, is perfectly interest inelastic, will the impact of expansion of the quantity of money be limited to the particular place the central bank lent the funds."
This is a massive oversimplification of what is happening, and the conclusion doesn't mean quite what you treat it to mean, even if it were accurate. The direction of existing saving supply is itself adjusted by the lower-interest lending.
If new money is offered at a lower interest rate it implies much more than what you seem to think it does. Firstly, it means that labor or the products of labor are being offered without the consent of the laborers. It is investment that was not explicitly supported by investors. Notice that the household no longer needs to save (make an investment), but the investment in drill presses still continues. Secondly, the lower interest rate allows not only for investments that might have not made sense at higher rates, but it also allows for larger investments into areas that already would have garnered some investment. Thirdly, you offer no support for your statement that money the household would have invested will now be spent on consumption. If I want to invest my money, it means I personally want more wealth in the future. I am not satisfied by the new investment created on everybody's behalf without my consent. If one particular avenue doesn't cut it because the central bank undercut my willingness to lend, I don't say "oh well" and go to disneyland. I look for other investments that might fit my willingness to lend. For example, I might notice that industry X is suddenly investing heavily in things that require drill press machines and see the possibility for large growth in that industry.
This brings me to a refutation of your idea that inflation can happen smoothly along with price levels. If our bank accounts all grew by the % of inflation, then maybe, but that's not how it works. Any industry that is boasting a high ROI will *attract* investment from folks who still want to invest, rather than giving up and going to Disneyland. This desire to invest remains, even in an inflationary economy. The new investment can further increase perceived ROI by stacking money onto the same portion of the market. New money as well as old money are sucked into this industry by investors who are no longer buying bonds, or stocks, because they have a lower ROI. Even if the supply of new money never stops, an amazing ROI has no incentive to stop growing further, because production will always happen slower than new investment can happen. Houses are an obvious example. Essentially, the industry with the biggest magnet attracting the new money, is the very industry that already commands most of the new money. Instead of all your prices inflating evenly, as you propose, all the new money packs into the one industry that beats the rest of the market. Does this sound familiar? Why on earth would a home buyer purposefully take out an unsustainable loan (new money) unless he expected the increasing home value would allow him to flip the home at a later date? Homes became THE inflation hedge that could be swapped, and the better they were in that capacity, the higher the ROIs seemed to be compared to the rest of the relatively non-inflating economy, and the higher the incentive for banks to create new loans, thus speeding up the rate of inflation.
ReplyDeletebasically, if you remove the value storing capacity of your currency, this drives people to find other places to store their value. Currency will still be fungible, unmistakable, divisible, etc, and it will lend all of those properties to anything that can store value, by acting as a medium of exchange.
Even if consumption does increase at some point, it's not because they didn't get to invest in something and instead spent their money. It's only because people did invest in something and incorrectly believe themselves to be wealthier than they actually are. In reality, the new wealth was mostly in the form of houses, or whatever inflating industry X is creating, and not necessarily in the same areas people are consuming from. Will you maintain your internet business that's giving you a 10% wealth boost per year, or will you stop working and buy a house that is increasing in value at 11% per year? Distortions in ROI beget worse distortions in ROI.
Normally, such rushes to invest only begin when there is a legitimate reason to expect growth in a particular industry (ie when that industry is expected to outpace the rest of the market in new value creation). If this increases output of value, the new money invested in that area is mapped onto more value, and prices actually tend to *fall*, curbing further investment. If no value is being created in that industry, prices will actually tend to *rise* because all this money is being mapped onto the same set of goods, which further *increases* prices and perceived ROI. This is why something that initially starts off as a good inflation hedge can grow into an investment bubble even under very smooth inflation.