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Booms, Bubbles, Busts, and Bogus Dichotomies

Having learned my monetary economics from both the great monetarist economists and their Austrian counterparts, I've always chafed at the tendency of people, including members of both schools, to treat their alternative explanations of recessions and depressions as being mutually exclusive or incompatible. According to this tendency, a downturn must be caused either by a deficient money supply, and consequent collapse of spending, or by previous, excessive monetary expansion, and consequent, unsustainable changes to an economy's structure of production.

During the 1930s and ever since, this dichotomy has split economists into two battling camps: those who have blamed the Fed only for having allowed spending to shrink after 1929, while insisting that it was doing a bang-up job until then, and those who have blamed the Fed for fueling an unsustainable boom during the latter 1920s, while treating the collapse of the thirties as a needed purging of prior "malinvestment." As everyone except Paul Krugman knows, the Austrian view, or something like it, had many adherents when the depression began. But since then, and partly owing (paradoxically enough) to the influence of Keynes's General Theory, with its treatment of deficient aggregate demand as the problem of modern capitalist economies, the monetarist position has become much more popular, at least among economists.

It is, of course, true that monetary policy cannot be both excessively easy and excessively tight at any one time. But one needn't imagine otherwise to see merit in both the Austrian and the monetarist stories. One might, first of all, believe that some historical cycles fit the Austrian view, while others fit the monetarist one. But one can also believe that both theories help to account for any one cycle, with excessively easy money causing an unsustainable boom, and excessively tight money adding to the severity of the consequent downturn. I put the matter to my undergraduates, who seem to have little trouble "getting" it, like this: A fellow has an unfortunate habit of occasionally going out on a late-night drinking binge, from which he staggers home, stupefied and nauseated. One night his wife, sick and tired of his boozing, beans him with a heavy frying pan as he stumbles, vomiting, into their apartment. A neighbor, awakened by the ruckus, pokes his head into the doorway, sees our drunkard lying unconscious, in a pool of puke, with a huge lump on his skull. "What the heck happened to him?," he asks. Must the correct answer be either "He's had too much to drink" or "I bashed his head"? Can't it be "He drank too much and then I bashed his head"? If it can, then why can't the correct answer to the question, "What laid the U.S. economy so low in the early 1930s?" be that it no sooner started to pay the inevitable price for having gone on an easy money binge when it got walloped by a great monetary contraction?

In insisting that one shouldn't have to blame a bust either on excessive or on deficient money, I do not mean to expose myself to the charge of making the opposite error. My position isn't that excessive and tight money must both play a part in every bust. Nor is it that, when both have played a part, each part must have been equally important. The question of the relative historical importance of the two explanations is an empirical one, concerning which intelligent and open-minded researchers may disagree. The point I seek to defend is that those who argue as if only one of the two theories can possibly have merit cannot do so on logical grounds. Instead, they must implicitly assume either that central banks tend to err in one direction only, or that, if they err in both, only their errors in one direction have important cyclical consequences.

The history of persistent if not severe inflation on one hand and of infrequent but severe deflations on the other surely allows us to reject the first possibility. What grounds are there, then, for believing that money is roughly "neutral" when its nominal quantity grows more rapidly than the real demand for it, but not when its quantity grows less rapidly than that demand, as some monetarists maintain, or for believing precisely the opposite, as some Austrian's do? New Classical economists, whatever their other faults, are at least consistent in assuming that money prices are perfectly flexible both upwards and downwards, leaving no scope for any sort of monetary innovations to affect real economic activity except to the extent that people observe price changes imperfectly and therefore confuse general changes with relative ones. Both old-fashioned and "market" monetarists, on the other hand, argue as if the economy has to "grope" its way slowly and painfully toward a lowered set of equilibrium prices only, while adjusting to a raised set of equilibrium prices as swiftly and painlessly as it might were a Walrasian auctioneer in charge. Many Austrians, on the other hand, insist that monetary expansion necessarily distorts relative prices, and interest rates especially, in the short-run, while also arguing as if actual prices have no trouble keeping pace with their theoretical market-clearing values even as those values collapse.

Of these two equally one-sided treatments of monetary non-neutrality, the monetarist alternative seems to me somewhat more understandable. For monetarists, like New Keynesians, attribute the non-neutral effects of monetary change to nominal price rigidities. They can thus argue, in defense of their one sided view, that it follows logically from the fact that certain prices, and wage rates especially, are less rigid upward than downward. That's the thinking behind Milton Friedman's "plucking" model, according to which potential GNP is a relatively taught string, and actual GNP is the same string yanked downward here and there by money shortages, and his corresponding denial of the existence of business "cycles." But "less rigid" isn't the same as "perfectly flexible" or "continuously market clearing." So although Friedman's perspective might justify his holding that a given percentage reduction in the money stock will have greater real consequences than a similar increase, other things equal, it alone doesn't suffice to sustain the view that excessively easy monetary policy is entirely incapable of causing booms. What's more, as Roger Garrison has pointed out, the fact that real output appears to fit the "plucking" story doesn't itself rule out the presence of unsustainable booms, which (if the Austrian theory of them is correct) involve not so much an expansion of total output as a change in its composition.

Austrians, in contrast, tend to attribute money's non-neutrality, not to general price rigidities, but to so-called "injection" effects. In a modern monetary system such effects result from the tendency of changes in the nominal quantity of money to be linked to like changes in nominal lending, and particularly to changes in the nominal quantity of funds being channeled by central banks into markets for government securities and bank reserves. The influence of monetary innovations will therefore be disproportionately felt in particular loan markets before radiating from them to the rest of the economy. It is not easy to see why monetary "siphoning" effects, to coin a term for them, should not be just as non-neutral and important as injection effects of like magnitude. To the extent that the monetary transmission mechanism relies upon a credit channel, that channel flows both ways.

A division of economists resembling that concerning the role of monetary policy in the Great Depression has developed as well in the wake of the recent boom-bust cycle. Only this time, oddly enough, several prominent monetarists and fellow travelers (among them, Anna Schwartz, Allan Meltzer, and John Taylor) have actually joined ranks with Austrians in holding excessively easy monetary policy in the wake of the dot-com crash to have been at least partly responsible for both the housing boom and the consequent bust. With so many old-school monetarists switching sides, the challenge of denying that monetary policy ever causes unsustainable booms, and of claiming, with regard to the most recent cycle, that the Fed was doing a fine job until until house prices started falling, has instead been taken up by Scott Sumner and some of his fellow Market Monetarists.

Sumner, like Milton Friedman, forthrightly denies that there's such a thing as booms, or at least of booms caused by easy money, to the point of taking exception to a recent statement by President Obama to the effect that, among its other responsibilities, the Fed should guard against "bubbles." But here, and unlike Friedman, Sumner basis his position, not merely on the claim that prices are more flexible upwards than downwards, but on a dichotomy erected in the literature on asset price movements, according to which upward movements are either sustainable consequences of improvements in economic "fundamentals," or are "bubbles" in the strict sense of the term, inflated by what Alan Greenspan called speculators' "irrational exuberance," and therefore capable of bursting at any time. Since monetary policy isn't the source of either improvements in economic fundamentals or outbreaks of irrational exuberance, the fundamentals-vs-bubbles dichotomy implies that monetary policy is never to blame for changes in real asset prices, whether those changes are sustainable or not. If the dichotomy is valid, Sumner, Friedman, and the rest of the "monetary policymakers shouldn't be concerned about booms" crowd are right, and the Austrians, Schwartz, Taylor, and others, including Obama and his advisors, who would hold the Fed responsible for avoiding booms, are full of baloney.

But it isn't the Austrian view, but the bubbles-vs-fundamentals dichotomy itself, that's full of baloney. That dichotomy simply overlooks the possibility that speculators might respond rationally to interest rate reductions that look like changes to "fundamental" asset-price determinants, that is, to relatively "deep" economic parameters, but are actually monetary policy-inspired downward deviations of actual rates from their genuinely fundamental ("natural") levels. Because actual rates must inevitably return to their natural levels, real asset price movements inspired by "unnatural" interest rate movements, though perfectly rationale, are also unsustainable. Yet to rule such asset price movements out one would have to claim either that monetary policy isn't capable of influencing real interest rates, even in the short-run, or that the temporary interest-rate effects of monetary policy can have no bearing upon the discount factors that implicitly inform the valuation of amy durable asset. Here again, the burden seems too great for mere a priori reasoning to bear, and we are left waiting to set our eyes upon such empirical studies as are capable of bearing it.

In the meantime, it seems to me that there is a good reasons for not buying into Friedman's view that there is no such thing as a business cycle, or Sumner's equivalent claim that there is no such thing as a monetary-policy-induced boom. The reason is that there is too much anecdotal evidence suggesting that doing so would be imprudent. The terms "business cycle" and "boom," together with "bubble" and "mania," came into widespread use because they were, and still are, convenient if inaccurate names for actual economic phenomena. The expression "business cycle," in particular, owes its popularity to the impression many persons have formed that booms and busts are frequently connected to one another, with the former proceeding the latter; and it was that impression that inspired Mises and Hayek do develop their "cycle" or boom-bust theory rather than a mere theory of busts, and that has inspired Minsky, Kindleberger, and many others to describe and to theorize about recurring episodes of "Mania, Panic, and Crash." Nor is the connection intuitively hard to grasp: the most severe downturns do indeed, as monetarists rightly emphasis, involve severe monetary shortages. But such severe shortages are themselves connected to financial crashes, which connect, or at least appear to connect, to prior booms, if not to "manias." That the nature of the connections in question, and the role monetary policy plays in them, remains poorly understood is undoubtedly true. But our ignorance of these details hardly justifies proceeding as if booms never happened, or as if monetary policymakers should never take steps to avoid fueling them. On the contrary: the non-trivial possibility that an ounce of boom prevention is worth a pound of quantitative easing makes worrying about booms very prudent indeed, and prudent even for those who believe that monetary shortages are by far the most important proximate cause of recessions and depressions.

Does my saying that Scott and others err in suggesting that monetary policymakers ought not to worry about stoking booms mean that I also disagree with Scott's arguments favoring the targeting NGDP? Not at all. I'm merely insisting that a sound monetary policy or monetary system is one that avoids upward departures of NGDP from target just as surely as it does downward ones. Nor do I imagine that Scott himself would disagree, since his preferred NGDP targeting mechanism would automatically achieve this very result. But I worry that other NGDP targeting proponents have allowed themselves to become so wrapped up in recent experience, and so inclined thereby to counter arguments for monetary restraint, that they have allowed themselves either to forget that a time will come, if it hasn't come yet, when such restraint will be just the thing needed to keep NGDP on target, or to treat Scott's boom-denialism as grounds for holding that, while there can be too little NGDP, there can't really be too much. (Or, what is almost as bad, that there can't be too much so long as the inflation rate isn't increasing, which amounts to tacitly abandoning NGDP targeting in favor of inflation targeting whenever the the latter policy is the looser of the two.) I urge such "monetarists" to recall the damage Keynes did by taking such a short-term view, while disparaging those who worried about the long run. "Keynesiansim" thus became what Keynes himself never intended it to be, which is to say, a set of arguments for putting up with inflation. Let's not let Market Monetarism become perverted into set of arguments for putting up with unsustainable booms.

Addendum: Scott has responded, claiming that I am wrong in portraying him as a money-induced unsustainable boom denialist. I appreciate his attempts to reassure me, and yet can't help thinking that he has nevertheless supplied some reasons for my having characterized his thinking as I did. For example, when Scott writes that "asset prices should reflect fundamentals. Interest rates are one of the fundamental factors that ought to be reflected in asset prices. When rates are low, holding the expected future stream of profits constant, asset prices should be high. Bubbles are usually defined as a period when asset prices exceed their fundamental value. If asset prices accurately reflect the fact that rates are low, then that’s obviously not a bubble," he certainly seems to accept the bubbles-vs.fundamentals dichotomy about which I complain above, with its implicit exclusion of the possibility of a boom based on lending rates that have been driven by "unnaturally" low by means of excessively easy money. Scott only reinforces this interpretation by further observing, in the same post, that "[i]t’s not clear what people mean when they talk of “artificially” low interest rates. The government doesn’t put a legal cap on rates in the private markets, in the way that the city of New York caps rents." Now if that isn't sweeping aside the whole Wicksellian apparatus, with its distinction between "natural" and "actual" interest rates, then I don't know what is.

Also, while Scott protests that he does not deny a possible role for easy money in fueling booms, it's far from evident that he considers this something other than a merely theoretical possibility. He denies (appealing again to the bubbles-vs.-fundamentals dichotomy), that monetary policy played any part in the Roaring Twenties (while asserting that NGDP per capita fell during that decade, though that isn't my understanding*); and he denies that it played any part in the recent housing boom. With respect to the latter boom he observes, in response to a commentator, that "a housing boom is just as likely to occur with 3% trend NGDP growth as 5% NGDP growth. Money is approximately superneutral. I completely reject the notion that Fed policy is mostly to blame for the housing bubble–it was bad public (regulatory) policies plus stupid decisions by private actors. I’m not saying Fed policy had no effect, but it was a minor factor." Scott's claim here, though not altogether wrong as a claim about comparitive steady states, might nonetheless be taken to suggest that there's little reason to be concerned about adverse effects, apart from inflation, of faster than usual NGDP growth. And this view in turn encourages people to think that, when NGDP grows more rapidly than usual, there's no harm in sitting back and enjoying it so long as it doesn't raise the inflation rate much. That is, it encourages them to favor replenishing the punchbowl whenever the party get's dull, but not removing it when the party starts getting wild.**

Regarded as empirical claims only, Scott's assertions may of course be valid. But I think the evidence from these and other quotes from him suggests that, while he clearly believes that easy money can influence interest rates, he does not believe, as a matter of theory, and based largely on his acceptance of the bubble-fundamentals dichotomy along with the EMS, as well as his related inclination to brush-aside Wicksell's arguments as to the possibility as well as the unsustainability of "unnatural" changes in interest rates, that by doing so it can contribute to an unsustainable asset boom.

*Here, for what it's worth, is the plot I get when I divide nominal NGDP (millions) by population (thousands) using stats from FRED's macrohistory data base:


**Previously I put the matter here in stronger terms that I now see were unjustified. Sorry, Scott! (Added 10/3/2013 at 9:36PM).


  1. Great stuff George. I will just add, for those here who aren't aware, my *Microfoundations and Macroeconomics: An Austrian Perspective* (2000/2009) tries to integrate the Austrian story of an unsustainable boom caused by excessive credit creation with the monetary disequilibrium theory account of the effects of too little money by bringing them under a common Wicksellian umbrella.

    In my IHS Learn Liberty Academy program on the Great Depression this summer, I explicitly argue the point George makes here about the 1930s: any good explanation of the Great Depression should include both the Austrian account of the boom and turning point and the Monetarist account of early 30s deflation, not to mention the work of Higgs and others on the real distortions of the New Deal. It's not an either/or, it can be both the booze and the frying pan.

    1. From listening to the Mises Institute lectures I thought that Higgs agreed with the Austrians on the issue of the Great Depression; that the trouble was the manipulation of interest rates by the Fed in the 1920s to prevent the price deflation that should have occurred when productivity improvements made products so much cheaper to produce. By inflating the money supply and keeping rates low the Fed promoted malinvestments that had to be corrected. Once the correction began what should have been a sharp but short contraction turned into a Great Depression because Hoover and FDR would not let the market liquidate those malinvestments. I see nothing in the work of the Monetarists that is necessary to explain (or predict) anything. It is interesting that Friedman thought that the 1920s and the 1990s were great periods for the Fed even though the Austrians were predicting at the time that massive corrections would be needed when the unsustainable practices of the Fed could no longer continue manipulating rates.

      1. In my opinion this view, which certain versions of the Austrian theory seem to be responsible for promoting, wrongly treats monetary contraction as a necessary accompaniment of the liquidation of boom-induced malinvestments. That's a serious error: no shortage of money is required to get interest rates back to their "natural" levels and to this end the boom and start a needed structural readjustment. But a money shortage means that interest rates rise above their natural levels. That's what happened, and happened in a big way, in the U.S. during the early 1930s; and it explains why the collapse of real activity was much worse than liquidation of prior malinvestment would have called for. So while monetarists may be wrong in denying that malinvestment was any part of the story, your opposite view that the Austrian theory tells the whole story, and that monetarists have nothing to contribute, is also quite wrong–which is the whole point of my post, really.

        I'll say it again for emphasis: the idea that a collapsing money stock, and associate collapse of aggregate spending, is necessary for the liquidation of prior excess-money induced malinvestment, is unsound. It's a perversion of the Austrian theory. And it is probably the main reason why that theory has been treated by so many, unfairly, as having been entirely unsound.

        1. Who is promoting anything inside the Austrian School? What the Austrians say is that the markets should decide what the appropriate money supply should be and that there is no role for a Federal Reserve System in dealing with the aftermath of a bubble that it created in the first place. For a guy who claims to be in favour of 'free banking' you certainly seem to have trouble with free markets. If people borrowed too much and don't need to borrow any more to buy overvalued assets it would certainly look to some as if there was a money shortage. But I do not think that is the case. After bubbles pop because of interest rates being held lower than what the market would have set we certainly do not need some authority with a monopoly on money creation to repeat the errors it made when it created the bubbles in the first place.

          You are obviously an intelligent person so why you cannot see things as they are is very puzzling to me. Perhaps you have too much invested in your view and have a sunk cost issue that prevents you from correcting your position. Perhaps those that advocate a bigger role for central banks and governments get better jobs and greater rewards. Whatever it is I can assure you that the position that you hold does not pass the smell test. This is exactly why Rothbard's arguments, flaws included, are making a huge headway and why the Chicago School is fading into obscurity. Rothbard makes a lot more sense and is a great deal more logical.

          1. I'm sorry, VangeIV, but I'm afraid that I see nothing in your arguments other than a nice illustration of precisely the extreme Austrian one-sided view of recession to which my post replies. (And your suggestion that yours isn't an "Austrian" view is betrayed by your remarks about Chicago economics fading into oblivion–a claim that no-one save a hard-core Mises-Institute Rothbardian could make with a straight face.) That my post takes some monetarists to task for also having a one-sided view is something you seem to overlook. I can't help noting, though, that while the monetarists have also sought to rebut my criticisms, they've all at least done so without all the obnoxious polemical chest-pounding that has made "Austrian economist" a synonym for "lout" among many generally thoughtful economists of other persuasions (thanks, Murray!).

          2. George writes:

            "And your suggestion that yours isn't an "Austrian" view is betrayed by your remarks about Chicago economics fading into oblivion–a claim that no-one save a hard-core Mises-Institute Rothbardian could make with a straight face."

            Sorry George but I am simply restating what Bryan Caplan clearly pointed out:

            "Future historians of thought will be puzzled by the transformation of the Chicago School. How does one get from Milton Friedman to Donald Wittman? My answer: Step by step, and myopically. More than anyone else, Friedman cemented the Chicago view that the free market is under-rated. Since many market failure arguments assume that consumers or workers are irrational, Chicago economists eagerly joined the rational expectations revolution. Initially, their new outlook made their defense of free markets more truculent; government intervention seemed even more pointless than previously believed. But this position was unstable. If people have rational expectations, how can the free market be "under-rated"? And if the free market is not under-rated, then what reason is there to second-guess democratically-chosen policies? This pointed question gnawed away at the intellectual conscience of Chicago economists until enough were ready to hear Wittman's unconflicted answer: There is no reason to second-guess democratically-chosen policies."

            You can read the rest at:

            Caplan is hardly an Austrian and at times practically seems to worship Friedman. So let us set the 'Rockwell made you do it' claims aside and deal with the issues rationally.

            My point still stands. Rothbard and the Austrians would let markets do their job. That means no central planning with regards to anything, including the money supply. That means no central bank. Now it is clear that you say that you are a libertarian and that you do oppose government and central bank meddling in the economy. Yet, when you had an opportunity to take a stand against QE you said that it was very necessary. And it is pretty clear that many of your arguments regarding fractional reserve lending depend on the existence of central banks and government regulations. There is no evidence that a true free market would tolerate fractional reserve lending, at least to the extent that it takes place today.

            Before I end let me admit once again that you know far more about this subject than I do and that you are probably a lot smarter than I am. My argument is simply that your premises are wrong and that no matter how great your intellect a logical structure that is built on sand is not very good or very stable. And that what also matters is our actions. We can claim to be against central banks all we want but when we make excuses for their actions and approve of their central planning we really cannot claim to be libertarians in principle.

  2. "Does my saying that Scott and others err in suggesting that monetary policymakers ought not to worry about stoking booms mean that I also disagree with Scott's arguments favoring the targeting NGDP? Not at all"

    Of course you wouldn't disagree with Sumner because your method has displayed strict adherence to the silly and fallacious assumptions about human action that all silly mainstream economists believe and adhere to, i.e. statist dogma. Considering that governments make their money through expropriate, which is unlike the private sector that requires people to create something of value and thus provide it on the market and others to purchase it with their wealth voluntarily, how can it be said that savings=investment using the silly calculations of GDP that include a G variable and T variable that are basically examples of capital consumption. What can be said about the of holding Treasury notes, is that there is already a natural tendency toward capital consumption, seeing as though Government money is expropriated money, it is not generated wealth.

    One can go on to point out that issuing government bonds does not inflate asset prices because the bond will be an investment in government duties. Yet where does this money that the government now has (supposed Equity on a corporate balance sheet if they were to issue bonds) go to? Well to fund its further miscalculation of capital goods and wasteful projects. In a free enterprise, the company must be on it's toes to make sure it's bonds are worth the solvency of its balance sheet, and thus add value to society through the competitive nature of the profit motive and raising standards of living. On the other hand, governments add no value to society seeing as though there is no competition in their sector. They can make companies poor by lowering prices enough to crowd them out of industries, relying solely on expropriated money to do so.

    Whereas private enterprise must take full account of the rate of interest and the debt they issue, government can freely issue debt while affecting the balance sheets of those very businesses reliant on the rate of interest and their cash flows. Government distorts the cash flows by taking the private enterprise' rendered profits. My argument would be that Government "Investment," is not Investment at all, but capital consumption. Thus how can one believe in the calculations of GDP, when it is a vast assumption on the savings & investment of a society. One can see within the capital structure that savings will always equal investment, but when government exists, we have an extra consumer, not investor. Not only that, but savings gets distorted for the businesses, while investment becomes illusive. It is the same credit expansion that is built on sand, that Mises speaks about. Let us not forget that the very capital good one human actor sees, is a consumer's good to another. Governments spend their time "only" consuming goods, not creating accurately priced capital goods for other business owners to use appropriately.

    For more importance on the decepetion of GDP, see here:

    1. You obviously don't know the difference between GDP and NGDP. The last doesn't pretend to measure anything but total spending. But I see that you have mastered the strident tone and flinging-around of the word "statist" that appear nowadays to be the key qualifications for regarding oneself as an expert in Austrian economics.

      1. Precisely Mr Selgin. NGDP is not a good measure for anything but the AS/AD curves you and Sumner enjoy using for your models. For the Aggregate Supply and Aggregate Demand curves you guys use are made up of the GDP formula I linked to and which is taught in every university on the planet. It the statist dogma I speak about. Aggregate Demand in the manner which Rothbard wrote about was an aggregate of all demand curves in the economy, or all value scales of individuals in an economy. But his method involved the ERE and thus explained the manner in which all things moved toward the state of rest. Your attempts to measure an economy, if I have this right, in strict adherence to your university teaching, use AD/AS curves that were invented by Keynes and his cult. Still I see no importance in NGDP unless of course the measures of total spending calculated were of the important factors not including government spending, which the CBO includes. I would see the measure of the Billion Prices index as more valuable than NGDP figures put out by the CBO to calculate the movement in prices. All this government infused modeling is hodgepodge for overpriced professors like you to keep making circular arguments about nothing. A much better economist than you has a great post on that today, see here:

        1. Sorry, adringuti, but you just supply here further proof that you don't understand the significance of what NGDP measures (unlike real GDP, no one claims that more NGDP is "better"; and while there are good reasons to doubt that G qualifies as part of an economy's valuable output, NG certainly does qualify as part of its total spending), or why arguments for stabilizing it don't depend on any specifically "Keynesian" doctrines. And in imagining mean to be an unthinking devotee of either Keynesian notions or of the extreme formalism that's now common in economics, you supply proof that you know as little about me as you know about NGDP!

          1. Mr Selgin, I still totally disagree that gathering Government spending in real terms, then seeing how the inflation adjusted form of this variable in Nominal terms really makes a difference. For government spending is bad from the beginning. I explained to you earlier how it's inclusion in any calculation is a pernicious form of deciding whether investment or consumption takes place in an economy. For Government Investment is as bad and equal to Government spending, they are both forms of capital consumption.

            If you truly believe in verbal delineation of economics, why use those government induced formulas and variables? There is no need to do so at all. In measuring the price of other goods, whether it be capital goods or consumer goods, one will take full notice of the rise in prices over a period of time without having to result to aggregating the total of spending. Furthermore, it is important to look at the prices of goods as individual homogenous classes, not as one whole aggregate or clump. This seems very contradictory to me anyway, how can you decide to use infinite steps with indifference analysis, but then go on to clump spending together within confined borders. This does not seem very Austrian or free-market oriented to me at all.

            "The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops." – LvM, Human Action

            Finally, I would hope that you take the time to remember the silly ideas you espouse that are thoroughly Keynesian and completely not Austrian at all that I have showed you getting stuck in a rut with both Jeffrey Hummel and David Henderson about; they were using the same silly models and assumptions you do!

            See here:

            And here:

          2. Would you please stop calling me "silly" and a "statist" and all that rot, adringuti. I mean, I have to moderate and approve your comments, and that makes my doing so feel silly indeed! Besides, I am beginning to worry that you might just be some wiseguy having fun doing some kind of comic caricature (though admittedly that isn't easy to pull off, since it's hard to do a caricature of something that's already a laughable) of a typical Mises Institute "educated" "hard-core" ultra-Austrian praxeologist, to see if you can get a charge out of me that way and then maybe get Jon Stewart to read it on The Daily Show.

            But it won't work, 'cause I've now wrangled with Rothbardian claptrap long enough to have become used to being called a silly statist Keynesian and so on. It used to bother me more, but then I discovered that the sort of people who resort to it imagine, for example, that the way you calculate NGDP and its components is to first "gather" up the real measures–all those tons of guns and butter–and then figure out, as best as you can, the nominal equivalent.

          3. Prof. Selgin, it's a shame that your thoughtful posts so often turn into lightning rods for vitriol and screeds from misguided Rothbardians, rather than opportunities for enlightened discussion on monetary issues. I sincerely appreciate your patience and vigilance in responding to the same baseless accusations and criticisms again and again.

          4. Thanks for the moral support, John S. I do sometimes wish the criticisms weren't so frequently coupled with remarks expressing doubts about my morals, competence, and sanity!

  3. If bank credit has expanded beyond the monetary base (i.e. banks have lent out "money" that does not really exist) then the credit must be allowed to shrink back down towards the monetary base (the actual money).

    If this means a "crash" that is unfortunate – but the fault lies with the build up of the credit bubble in the first place.

    As for government supporting the banker credit bubble – either by corrupt court judgements ("suspending cash payments" – which is only going to delay, not prevent, the inevitable anyway) or the active expansion of the money supply by the government (or its Central Bank – such as the Federal Reserve)….

    Well someone who supports government support of banker credit bubbles should not call themselves a "Free Banker".

    I repeat – all credit bubbles (if not supported by government) eventually burst, and the credit bubble (the credit expansion) must be allowed to shrink back towards the actual money.

    Demanding government (or Central Bank) support for banker credit bubbles is not compatible with someone calling themselves a "Free Banker".

    The banker credit bubble (the credit expansion financed malinvestments) must be liquidated – the "crash" must be allowed to run its course.

    1. So I am "Demanding government (or Central Bank) support for banker credit bubbles"! Interesting take on what I wrote, Paul.

      1. I do not think that you do but his comment, "Well someone who supports government support of banker credit bubbles should not call themselves a "Free Banker"," may be appropriate. It seems to me that you are playing on both sides of the street on this. How can a 'free banker' support government manipulation of rates and credit?

        1. This is ridiculous: the whole thrust of my comment is that government (and central banks in particular) should avoid "supporting" bubbles! If you show me were I suggest otherwise, I'll eat my hat!

          And I have never wavered from treated free banking as a preferred reform. It so happens, though, that we are a long way from having it, and that even if we did we would, if we would need to have some rule or policy in place to maintain the scarcity of the monetary base. (Free banking itself doesn't do anything to the base.) That could be gold, a fiat base freeze, or something else. I've shown that with free banking and either gold or a frozen base, there's a tendency toward stabilization of total spending. So I consider the achievement of such stability by existing central banks an appropriate "second best" policy. I don't think it accomplishes a damn thing to just talk about the first best ideal while keeping mum about what the Fed ought to try and do. For one thing, to refuse to do so implicitly is to refuse to ever make comments to the effect that the Fed has blown it this or that way. Every hard core Austrian who characterizes someone like me as selling out because we say the Fed "ought" to do X rather than Y doesn't seem to realize that they do exactly the same thing when they say, for example, that the Fed's easy money policy in the late 20s contributed to the consequent depression. "Easy" compared to what? Well, presumably, to some implicit alternative policy. (And bear in mind that gold itself was piling up in the Fed's coffers during the 1920s, and that if the Fed had let the gold inflow give rise to proportional credit growth, instead of sterilizing much of it, there would have been more rather than less credit expansion.)

          1. Mr Selgin you're missing the actual cases that are arising in circumstances where there is presently little to no government involvement, and this includes in areas such as banking and money. Bitcoin is a unique phenomenon that has shown banking can actually rid itself of fiduciary media, and other dynamics such as lending club or the infinite banking concept are showing that loan banking and deposit banking are tending toward separate functions on the free market. Perhaps there would be cases where FRB banks exist, but in reality people want sound banking, and if that means using reloadable cards or separate institutions and their various functions on the free market, then people will tend toward that modicum of satisfying their time preference. It is misinformed and a naive adherence to one's overpriced education to think outside of their realm of the ridiculous models and mechanics taught to them by their narrow minded professors.

          2. Let me see if I can put this clearly. Since English is not my first language forgive my lack of eloquence. When I watch the Syria debate on the cable channels I see the pictures and sounds that argue for war regardless of what the talking heads are actually saying. Many parse their words and are clearly being careful not to be caught up by careful analysis of what they said. But that is not important because of the tone and all of the other things that provide viewers with a very clear message. When I read you and some of your colleagues I get exactly the same impression. There is a tone and a certain 'soundtrack' for lack of a better word that provides your readers that yours is far more a statist position than you may actually hold. It is clear that some of your readers pick this up, which is why you get so many responses that have a similar tone but argue for the opposite.

          3. hamblin, the remark you quote refers specifically to fiat money. Commodity money is naturally scarce, and market forces can regulate its quantity in a manner that at least tends to limit long-run changes in its purchasing power. But despite speculation about "competing fiat monies," it is doubtful that profit-maximizing issuers of fiat money can be relied upon to resist a temptation to over-issue. Larry White treats the matter at some length in his Theory of Monetary Institutions.

    2. Paul,

      There is normally no need for malinvestments to be liquidated. As it explains in the economics text books, the fact that an investment cannot repay fixed costs is not a reason to close it down, as long as it can cover variable costs.

      Also, while I don’t approve of central banks making artificial adjustments to interest rates, I doubt the amount of malinvestment that derives from artificially low rates is all that serious. To illustrate if rates are 2% below free market rates, that is a very small change to the TOTAL COST of running an investment because the latter total cost includes depreciation, insurance, associated energy and labour costs, etc etc.

      1. Sorry Ralph but I do not think that you are thinking this through. The free market will do what is necessary and appropriate but not if it is not allowed to as happens when governments encourage lending to businesses that are failing and the Fed is manipulating interest rates lower. The market would transfer assets from weak hands to those that are far more capable of using them effectively. All that the Austrians are saying is that the market should be allowed to do its job so that the basis of a strong economy can be reestablished as quickly as possible before more damage is done as is the case when businesses that should be allowed to fail are propped up. Had Japan allowed the markets to clear away the debris after its crash it would not have been in a depression for nearly two decades and looking over the economic abyss.

  4. You must be getting as tired as me George – I did not name you in my comment, and I was clearly writing about the topic itself (not your specific post upon it).

    However, as you raise the matter, I take it that after 1929 you would have allowed the banks to go bankrupt and the bank credit to shrink back towards the monetary base?

    The so called "fall in the money supply" after 1929 was not really a fall in the money supply at all – no one went around burning Dollar notes with a flame thrower, or melting down coins.

    The so called "deflation" was actually the collapse of a credit bubble. It is quite true that the commercial bankers were NOT entirely to blame for this credit expansion (this credit bubble) of the 1920s – they were led (every step of the way) by the terrible Benjamin Strong of the New York Federal Reserve (a man that Milton Friedman praises – thus showing a radical lack of understanding of this particular matter), but the credit expansion (the credit bubble) did happen.

    And once such a bubble is created, it will (eventually) burst – then government (and the Central Bank) faces a choice.

    Intervention (to "maintain the money supply" – i.e. prop up the credit bubble).

    Or non-intervention – allowing the liquidation to run its course.

    As you ask – I do suspect that you would support intervention (although I will be happy if you say that I am mistaken in that).

    Still there is one form of intervention that we would both oppose – the form of intervention that Herbert "The Forgotten Progressive" Hoover actually followed.

    Not monetary policy intervention – but supply side intervention.

    For the first time in American peace time history a President, in the face of a bust, tried (and tried desperately) to keep UP prices and wages (the price of labour) by government intervention. Never before in the various crashes the United States had faced (from 1819 to 1921) had a President followed such a policy.

    It was this (Herbert Hoover – a man in the grip of the "demand" fallacy) that turned the crash of 1929 into the Great Depression.

    And it makes it amusing (in a smash-ones-fist-against-the-wall-till-it-breaks sort of way) that school and college history textbooks present Hoover as a "noninterventionist".

  5. A British note is of interest here.

    There has been a lot of bafflement (in media, and academic, circles) about how unemployment has not gone up (in the face of the economic crash) "even though real wages have fallen".

    It does not occur to these media (and academic) folk, that unemployment has not gone up (in the face of the economic crises) BECAUSE real wages have been allowed to fall.

    Calvin Coolidge would have understood the above, but an educated man such as Herbert Hoover would have great difficulty in understanding it.

    "But that means there will be less demand – and less demand means less jobs" was the fallacy he was caught in.

  6. I have already replied (twice) pointing out that I have NOT launched any attack on George Selgin in this thread – my comments have been about the topic itself (not any particular post upon the topic).

    By the way, there was something I forget to point out in either of my previous comments (the comments that have not appeared), this is that I used to support the bail-out-the banker-credit-bubble position (which is what maintain-the-money-supply prevent-a-deflationary-crash position actually is).

    As a child (even I was one once) I used to think about monetary policy walking to-and-from school ("but Paul – were you not too busy fighting the sabre toothed tigers outside your cave?").

    My position, at that time (not now), was that the government should physically print money (fiat command-order money – which gets its, dark, "value" from legal tender laws and tax demands) to back up a banker credit bubble (the so called "money" produced by the banking system) in order to prevent a collapse. The fiat money to be GIVEN (not "lent") to banks – in return for a strict end to bubble creation by bankers.

    This is no longer my opinion – partly for reasons of economic theory, but also for practical reasons. The principle practical reason being the ability of governments and bankers (and their defenders) to come out with "scientific" sounding double-talk to justify their activities. The jargon is so ingrained that it may no longer actually be an intentional effort to deceive – bankers (and their defenders) may really have lost the ability to talk in normal English about their activities (or even think in normal language about what they are doing).

    They (the bankers) simply can not be trusted to stop creating credit bubbles (even as a condition for the gift of vast amounts of fiat notes and coins), they properly would not know how to operate in a straight manner – even if they sincerely wanted to. Bankers have been trained in certain hopeless ways of keeping books (treating loans as assets, "crediting to the account" of borrowers rather than lending out physical money, and on and on…..) that, perhaps, leave them so confused that they are not really engaged in a conspiracy to defraud at all – they (and their defenders) may simply (and honestly) have lost all grasp on reality.

    However, in either case (dishonesty – or mental confusion) – giving them more money is not a sensible response. The only sensible response is to allow bankruptcy – both for the banks and for the financial system itself (in spite of the fact of all the horror that will result – and I have already said, several times, that I fully accept that it will lead to my own death).

    Ralph Musgrove.

    Mr Musgrove – do I really have to tell you how much respect I have for "economics textbooks" on monetary matters (such as the claim that malinvestments do not have to be liquidated)?

    Is it not enough to say that I hold a similar amount of respect for them as I hold for your British National Party?

    1. So what’s your problem with the BNP? Given that the Labour and Tories took part in the slaughter of a million Muslims in Iraq, whereas the BNP opposed the war right from the start, at least the BNP are nowhere near as racist as Labour or the Tories.

  7. I should remind everyone that the above is not an attack on "fractional reserve banking" as a normal human being would understand the term.

    Bankers can lend out 100% of the physical money entrusted to them – as long as they tell investors that they are NOT "depositors" (a bank is not a grain silo – stuff is not really "deposited" there).

    A bubble can NOT result from the banking system lending out nine tenths (or even ten tenths) of the physical money that is invested with them. Only (by the various complex antics, interactions, of the players in the system) if MORE than ten tenths of the physical money entrusted to bankers is lent out (say, for example, ninety tenths – or 900 tenths) is turned into credit (of one sort or another) has a bubble been created.

    All such bubbles must burst – unless there is government intervention to save them (and Alan Greenspan did that MANY TIMES before 2008 – each time making the eventual crises worse and worse), and government intervention (far from being with the string attached of "stop the madness") is normally in the form of "loans" – with bankers being implicitly (or even explicitly) pushed by governments and their Central Banks to carry on the madness (indeed to expand it).

    I repeat that due to the "education" of the establishment (the governments, the bankers and their academic defenders) they can be expected to operate in a straight manner – even if they sincerely wish to do so.

    The language (and habits of mind) they have been taught – cut off that possibility.

    They (the present system) must go – sadly (and it is terrible – I do not deny that) it is the only way.

    1. "Bankers can lend out 100% of the physical money entrusted to them – as long as they tell investors that they are NOT "depositors" (a bank is not a grain silo – stuff is not really "deposited" there)."

      I think that this is a very good point. When many of us talk about fractional reserve banking we do not mean guaranteed deposits that are supposed to be immediately accessible. As far as I know many of the critics have no problem with the idea of money market funds, which get around many of the objections.

  8. VangelV,

    To repeat, I don’t approve of central banks manipulating interest rates (except possibly in emergencies), nor do I approve of “governments encouraging lending to businesses that are failing”.

    However, I don’t agree with your claim that “All that the Austrians are saying is that the market should be allowed to do its job..”. Austrians typically make an additional claim, namely that we need to endure years of purgatory to escape the above misallocation of resources. E.g. as Paul puts it above “the "crash" must be allowed to run its course.”

    The fact is that even at full employment or when the economy is at capacity, there are still hundreds of businesses failing every week, and hundreds of new ones starting up. Thus there is absolutely no need to endure a “crash” or excess unemployment in order to close down failed businesses, and get replacement businesses up and running.

    1. "To repeat, I don’t approve of central banks manipulating interest rates (except possibly in emergencies), nor do I approve of “governments encouraging lending to businesses that are failing”."

      If you do not call for the demise of central banks than you are clearly approving their manipulation of interest rates because that is what central banks do; they engage in monetary central planning and manipulate interest rates. And why would a rational person allow the banks to respond to emergencies that they created in the first place? Why not just let the markets do their job?

      Many people here talk about misguided Rothbardians but at least the Rothbardians are very clear on the subject. Flaws and all they still recognize that as long as you have monetary central planning you will never have a free market. It is ironic that Mr. Selgin seems to hold very similar views as many of the Austrians but because he has a tendency to use 100 words when 35 might be adequate, and by his unwillingness to take a more direct approach to reaching his conclusions he makes it difficult for the typical reader who is not already familiar with his views to make him out to be a much greater apologist for statism than he really is.

      What gets to me is that he has undermined the success of Rothbardians like Ron Paul in finally getting the central bank and the Krugman types that defend it to respond to some very clear critiques. When Dr. Paul was able to raise the issue among the public, the media, and even among academics good old George was out guns blazing attacking his position on fractional reserve lending and supporting Krugman. He claims to oppose central banks and monetary central planning yet he defended quantitative easing. As I wrote before, it seems to me that in this game there are too many people playing both sides of the net. There is a time when we have to choose and clearly state the principles that we really stand for.

      1. Your problem, VangeIV, like that of so many self-styled Austrians who are in fact not economists at all, is that you don't know the difference between economics and politics. You think that an "economist" must choose which "side" to be on, and accuse me of playing "on both sides of the net" because you can't grasp that, so far as I'm concerned, and so far as any real economist is concerned, "doing' economics isn't about embracing some ideology rather than another. It's about getting the positive understanding of how an economy works right. That's why I don't ask what someone's politics are before deciding whether that person's economics are sound. It's why I'm not going to give a free pass to a wrong opinion about banking because Ron Paul (whose politics I rather admire) expresses it, and its why I refuse to automatically disagree with any opinion expressed by Paul Krugman (whose politics I rather abhor).

        Rothbardians like you pretend to know economics. But you don't even know what it is. You think its just libertarianism. You think it's as easy as declaring, in response to any conceivable question of economic doctrine or analysis, no matter how intricate, that the economically sound answer is the one implied by the catch phrase, "Smash the state!" In short, you see things in nice black and white terms, because you your "analysis" begins and ends with your ideological convictions, with the economics consisting of nothing more than strident declarations of the evils of government. Were I interested in making myself popular among believers in free markets it would of course be the easiest thing in the world for me to turn into the sort of economist you admire. But so far as I'm concerned, that would truly be selling out.

        1. "Your problem, VangeIV, like that of so many self-styled Austrians who are in fact not economists at all, is that you don't know the difference between economics and politics. "

          I think that your personal animosity towards some of the Austrians (Rothbard being the primary example) makes you blind to some of their positions. When we are dealing with moral and intellectual principles it is hard to be true to them when you keep violating them or supporting those that oppose them. And having spent more than a few hundred hours in lectures by Allan Bloom, Thomas Pangle, Clifford Orwin, and others I would like to think that I understand politics probably as well as you do even though I have little experience in academic political intrigue that you are probably more familiar with.

          "Rothbardians like you pretend to know economics. But you don't even know what it is. You think its just libertarianism."

          I cannot speak for others but I am not pretending anything. But your comment brings to mind a critique of economists made by Nassim Taleb, who pointed out that the problem with the field is that its players were empty suits who thought that they understood far more than they do. When economists create all those nice models that think represent reality they are no different than the climate alarmists who depend on models to come to conclusions that will never be validated in the real world. As a practical person one of the big draws for me is the Austrian school's ability to make predictions that monetarists and Keynesians cannot make. I remember Friedman arguing that the price of gold would drop to around $16 or so because that was its value as an industrial metal, mainly as a dental alloy. At the time the Austrians were arguing that the dollar's value was propped up by its link to gold and that once the link was severed gold would go much higher in price. I also remember Friedman talking about how great Greenspan was in managing the economy almost to the day that he died. That was the time when the Austrians were screaming about the housing bubble that Greenspan created in response to the bursting of the tech bubble that the Fed helped to create. It was very clear that the Austrians were right and that their ideas about real world economics were closer to reality than the alternatives. Then there is the moral arguments. Unlike Friedman I believe in moral principles from which we can derive rules about how civil society should function. These principles are not many and can be distilled down to non-aggression. It is clear that when there is central planning of any kind the state is engaging in aggressive activities against some of its citizens. A good libertarian is not one who would minimize the pain by allowing the state to be more efficient but one who would stand up on principle and point out that the activities are wrong in the first place. Clearly you take a Thracimican view of politics that relies on moral relativism. That pays well these days and I am not surprised why academics are attracted to it. It is far easier to excuse the actions of unjust activities by those in power than to point out that the actions are not just. The only problem is that in the end reality always intervenes and that try as we might we cannot escape its consequences. The Austrians have predicted as much and have made very clear that fiat currencies and the banking system are not very stable, and that small fixes that kick the can down the road can only work for a limited period of time before a correction becomes necessary. If that happens everyone will see that the Austrian view of economics is far superior to the alternatives.

        2. I just registered an account to tell you how much I love this post. Accurate and eloquent.

  9. I have thought for some time that all theories of business cycles are right at some point in the cycle. The Austrian theory provides the skeletal framework while the others flesh out the details. Monetarism is not so much an explanation of crises as a description of what happens after the crises begins.

    We need to keep in mind the destruction in the value of capital that is revealed in the crisis. Thousands of houses setting empty and auto manufacturing plants idle represent the evaporation of huge amounts of invested capital. It takes quite a while to sell that capital and free the funds for further investment.

    As for Friedman and his "plucking" model, the reduction in money appears to be a consequence, not a cause. When people pay back loans early or default, the money supply naturally contracts.

    1. "I have thought for some time that all theories of business cycles are right at some point in the cycle. The Austrian theory provides the skeletal framework while the others flesh out the details. Monetarism is not so much an explanation of crises as a description of what happens after the crises begins."

      I am sorry but you just lost me. I am unaware of any business cycle theories that take the Austrian approach se cannot see how they can possibly 'flesh out the details.' Is there a reference available so that I can increase my knowledge of this?

      "We need to keep in mind the destruction in the value of capital that is revealed in the crisis. Thousands of houses setting empty and auto manufacturing plants idle represent the evaporation of huge amounts of invested capital. It takes quite a while to sell that capital and free the funds for further investment."

      Since value is subjective and the manipulation of interest rates encourages unwise investments in capital this should not be surprise.

      "As for Friedman and his "plucking" model, the reduction in money appears to be a consequence, not a cause. When people pay back loans early or default, the money supply naturally contracts."

      I agree. When an unsustainable bubble bursts individuals need to adjust and when they do the money supply will contract. The debate is whether the contraction should be allowed or whether the central banks should provide liquidity to lessen the pain to those that made bad choices. And that is what seems to drive a wedge between George and most Austrians.

      1. Non-Austrian theories all assume they tell the whole story about business cycles. Only the ABCT tells the whole story. We have to ignore their assumptions that they tell the whole story and see them for what they really are – descriptions of what happens at different points within the ABCT. At some point the psych theories kick in; at others the monetary theories; at still others the demand theories work.

        1. It amazes me, McKinney, that you can have read my post, with its opening complaint about the phony dichotomy whereby it is held that either the Monetarist theory alone is entirely right, or the Austriann theory alone is, and make the comment you make. All those sentences wasted. What's the use!

          If reason won't work on either-or-ists like yourself, perhaps an incantation will. How about, "A pox on both your houses!"

          1. And it amazes me that you can accept anything that the Monetarists claim given their methodology and their track record. I see little that they add to the analysis that the Austrians do not deal with correctly.

            A perfect example was the QE issue. Like the Monetarists and Keynesians, you thought it necessary that the Fed do something to deal with the liquidation of malinvestments. The Fed did and the financial institutions that created the problem were bailed out. But the problem was not solved and we are now in a more dangerous place than we were before QE began. The bond bubble is much bigger and the phoney economy is no more sound than it was before the correction began. Had the advice of the Austrians were followed there would not have been a series of bubbles created by the Federal Reserve system and no need to meddle in the economy any further. But their advice was not followed because fools like Friedman said that Greenspan got things right and was responsible for the best economy and most stability ever. So you will excuse me George if I keep arguing that the sooner that the Keynesians and Monetarists are buried and forgotten the better off society will be. Warts and all the Austrian School stands heads and shoulders above the rest and it is time that people like you took a stand on principle and also realized that things may not be as you think that they are.

          2. VangeIV:

            1. An Austrian post-boom liquidation process does not require a contraction of spending, which only causes new distortions. If you want to cheerlead for Austrian economics, you should at least get the theories right.

            2. I've myself been a consistent critic of the Fed's post-2007 bailouts, and indeed of any central bank support for insolvent institutions. If you want to criticize people, you should at least get your facts about their views right.

          3. "1. An Auatrian post-boom liquidation process does not require a contraction of spending."

            Does it not? Wouldn't a liquidation of assets contracts the money supply, which consequetly must contract spending?

          4. Enlightened etc.: A post-boom liquidation could certainly lead to monetary contraction, especially if it triggers widespread bank failures or a loss of confidence in the banking system. But it doesn't require any such contraction; and the contraction itself interferes with the orderly reallocation of productive resources, by causing viable enterprises to suffer along with those that are not viable.

          5. Actually, I thought I was agreeing with you, but taking the discussion one step farther. I agree that the dichotomy is not real, but then I think you have to deal with contradictions. Both the theories can't be 100% correct because at many points they contradict each other. There are good reasons that people see a dichotomy. In order to resolve the apparent dichotomy, one or both theories have to be modified.

            " An Austrian post-boom liquidation process does not require a contraction of spending, which only causes new distortions. "

            I agree, and that's where the monetarist theory applies. But a collapse in spending does not cause the recession; it is the recession. Monetarists don't provide a cause of the recession, just a description. Once the collapse in spending occurs it's reasonable to try to alleviate it, as Hayek wrote. However, monetarists obviously haven't enjoyed much success.

            Better still is to not let monetary policy create an unsustainable boom. Monetarists seem to be asymmetrical on the power of monetary policy. They think it can do good during a recession, which it can, but they don't think it can ever do any harm.

            And we don’t have to accept the monetarist idea that they can restore the economy to health with endless monetary expansion. They can't and have proven that. Once prices have stabilized, they should let interest rates rise to market levels.

          6. George writes:

            "1. An Austrian post-boom liquidation process does not require a contraction of spending, which only causes new distortions. If you want to cheerlead for Austrian economics, you should at least get the theories right."

            Perhaps the fact that English is not my native tongue causes me to use the wrong word occasionally but I believe that the point was clear and correct. Austrian theory wants the market to decide what happens to the supply of money and credit. This is very different from your position in which the damage caused by the bursting of a bubble created by too much liquidity is somehow to be minimized by creating even more liquidity and creating more distortions.

            "2. I've myself been a consistent critic of the Fed's post-2007 bailouts, and indeed of any central bank support for insolvent institutions. If you want to criticize people, you should at least get your facts about their views right."

            Did I not hear you in an interview where you claimed that QE was necessary? I just went into Google and searched for the terms "george selgin qe support". It provided a link to that video, which you can find here:


  10. Mr Musgrove.

    As I have told you before, I oppose Peronism – both its economic ideas (for example that the it is good thing for the state to directly increase the money supply) and its politics.

    I am opposed to the political and economic ideas of such people as Mussolini and Peron.

    However, I do not claim (as so many people do) that the BNP are Nazis. Fascism and National Socialism are not the same thing.

    Adolf Hitler and his political movement are quite different (most obviously in their desire to murder many millions of human beings) – to lump them with people such as Mussolini or Franklin Roosevelt (remember what trouble Ronald Reagan got into for reminding people how much the New Dealers openly admired Mussolini in the early to mid 1930sm before Mussolini's alliance with Hitler, – deliberately copying his policies, Reagan told the truth and the media, and academia, HATE that) is silly.

    People such as Gerneral Johnson (head of the National Recovery Administration – with his private army of "Blue Eagle" people) or Nick G. of the BNP can NOT usefully be compared to Adolf Hitler.

    It must be remembered that Hitler (unlike Peron or Mussolini indeed, although I regard him as utterly wrong, I must admit that Mussolini was a genuine intellectual – a man who could speak several languages and was very well read indeed)) was not really interested in economics at all – Hitler made nods towards socialism (because almost everyone did in Germany at the time – see Ludwig Von Mises and F.A. Hayek on this), but his primary interest was in the extermination of millions of human beings (not just Jews but others also).

    This can not even be usefully described as "racism" – as the Jews could not really be described as a "race" in biological terms (there are Jews of every race) and Hitler even had a fanatical hatred of Slavs (including tall, blond Slavs – who looked far more like "superior people" than, short and dark, Hitler himself did).

    The only way to tell many of the Slavs that Hitler hated from many of the Germans he adored was by what LANGUAGE they spoke (even the aristocratic families of Germany had intermarried with "Slavs", i.e. people who spoke one of the languages of this language group, for more than a thousand years).

    This is not "scientific racialism" – it is a farce.

    Unlike Fascism, New Dealism and Peronism (which can be considered economic and political philosophies – although, I believe, false ones), National Socialism is best understood as a farce – although a farce that led to many millions of human beings being murdered (often for no clear reason – for example the murder of some six million Jews, an event that, as far as I know, nobody has ever been able to offer a rational explaination for, the murders serving no purpose what-so-ever – indeed diverting vital materials and transport away from the German war effort,).

    Short version.

    I believe that Adolf Hitler is best understood as a lunatic (someone in the grip of severe mental illness). I do not consider General Peron, Mussolini, or the leadership of the British BNP to be lunatics.

    But I do not support them either. I reject both their political philosophy and their economic ideas. I want a smaller government (a fundamentally smaller government) not a fundamentally larger and more intrusive one.

    1. Paul, I think the discussion you are having with Ralph is way off topic. Kindly see about arranging to pursue it with him elsewhere lest it should crowd-out more relevant matter.

  11. Yes – for once I agree with you George.

    My comments (before the discussion with Mr Musgrove) were about the topic ("Booms, bubbles and busts" – although NOT confined to your post on the subject as I find the language you have been trained to use profoundly unhelpful). However, the conversation with Mr Musgrove had moved on from that.

    I have a personal dislike of his political party (I must confess that my character is given to forming grudges and acting on them), I must put that subject aside – in order to be fair.

    So I will just repeat that, on banking and monetary policy (indeed "macro" economics generally), I regard the language in economics textbooks (which has been presented to me for 30 years – so I am certainly not ignorant of it) as profoundly unhelpful and misleading (to put it mildly).

    Rather like someone insisting on using the language of astrology in a conversation about astronomy.

    1. Thanks, Warren. It's always a pleasure to get a favorable comment here, and especially one from someone who has neither an Austrian nor a monetarist axe to grind!

    2. Although I would characterize myself as a Rothbardian internet neckbeard troll, I also tend to think that your post is generally correct.

      1. Well then, Enlightened etc., I suspect you will get some flack for it from some of your fellow "RINTs" as I am now pleased to be able to refer to them!

  12. It seems to me that the biggest problem with modern fractional reserve banking is that banks are allowed to count treasury bonds as reserves. This turns banking into an outwardly spiraling counterfeiting scheme.

    Since we know that early Scottish free banks lent soundly on 2% reserves, the difference must be that since T bonds are non -Say's Law money, that lending on these "assets" usurps the entire process.

    1. This makes little sense. If Treasury Bonds are "reserves" then the Fed mustn't do anything to total reserves when it buys Treasury Bonds on the open market. (I also don't know what "Say's Law Money" is.)


          As I don't know how to post images in your comments, I'll have to post a link.

          The aggregate money velocity 1879-1914 resembles a decaying exponential curve, with normal business cycle oscillations. When V declines below 2, the oscillations become somewhat unstable.

          The explanation or this decay is the fractionalization of government bonds. In 1879, treasury bonds were issued to raise cash to redeem Lincoln greenbacks which amounted to .35 of GDP at the end of the Civil War. (Greenback dollars had been discounted to
          $0.62 in the market)

          I would define Say's Law money growth as m'/m = Q'/Q, i.e. where money supply growth is the same as commodity supply growth.

          Fractionalization of government debt causes m'/m-Q'/Q = c > 0. While banks may wish to earn income from buying T bonds when interest rates are low, lending against them is the cause of the inevitable credit glut which follows.

          1. First, the complexity in the economy cannot be modelled by a few linear equations so let us stop pretending that they can tell us very much. Second, how exactly does the Fed MEASURE V?

  13. The idea that the Federal Reserve should buy "Treasury Bonds" (government IOUs – worthless c…) or should produce money to enable others to buy government (or other) debt is demented – but I doubt that ending it would end the problem with FRB (at least with certain interpretations of FRB).

    I think we are back to other Currency School "right about the problem, wrong about the solution" thing (as Hayek and Mises put it – and they were not attacking the economic ideas of the Currency School, just the assumed "solution" of Sir Robert Peel's 1844 Banking Act).

    Let us say that the government had no deficit (indeed no debt – and it is terrible how many politicians do not even know the difference between deficit and debt) – would that sole the problem of credit bubbles?

    No it would not.

    For example President Martin Van Buren inherited a balanced budget and no national debt (no "T Bills").

    Yet he also inherited a massive credit bubble from Andrew Jackson's favoured "pet banks". A credit bubble that blew up in Van Buren's face.

    True they (the bankers) had played pyramid schemes with government tax money (which is why Van Buren set up the independent treasury system – to try and keep money away from pyramid scheme bankers), but even without any government money (without any tax money at all) bankers are quite clever enough to invent all sorts of vast pyramid schemes.

    I did say "clever" – not wise (not the same thing).

    Actually "Pyramid Scheme Banks" would be a better term than "Fractional Reserve Banks" -as the term "Fractional Reserve" (as a normal person would understand the word "fraction") does not really even hint at the problem.

    By the way there are several of my comments on Kurt S.s post that have not appeared yet….

  14. The central point of the article – that there is a "bogus dichotomy" between the Austrian School and the Monetarist School is mistaken. It is a real (not a bogus) dichotomy.

    For example, either Benjamin Strong (the head of the New York Federal Reserve) followed good policies (as Milton Friedman maintained) or he followed terrible policies (as Frank Fetter maintained).

    Nor can one, legitimately, say "well I accept that Benjamin Strong created a credit bubble – but the massive deflation after 1929 should not have been allowed".

    This supposed "massive deflation" was not someone going around with a flame thrower burning Dollar bills and melting down coins – it was nothing more or less than the collapse of the CREDIT BUBBLE of the late 1920s.

    As with the crash of 1920-1 the crash of 1929 should have been allowed to run its course.

    And prices and WAGES should have been allowed to freely adjust to the crash – which is not what President Herbert "The Forgotten Progressive" Hoover did. Hoover (for the first time in American peace time history) actively intervened to try and PREVENT the labor market clearing.

    The above is not being "Rothbardian" (although the late Murray Rothbard would, most likely, would have agreed with it).

    Murray Rothbard was three years old in 1929 – he was not a big player in the economic debates of the time.

    What I have done above is to give an account of the position of the leading "Austrian" School people (although, for example, Frank Fetter was actually from Peru Indiana) of-the-time.

    Short version.

    It is not a "bogus dichotomy" it is a real one.

    1. The Fed's post 1929 policy of lending only against Real Bills (commercial notes of less than 60 days duration) is commonly pointed at as prolonging the Depression. I think this is unfair because what is overlooked in these discussions is the effect of FDR's dollar devaluation from 1/20.6 to
      1/35 gold oz. in 1933 which wiped out 43% of household savings during a time of high unemployment.

      I think it is very likely that squeezing out the excess credit would have led to a quick recovery had there been no devaluation.

  15. Actually this is a very generous way of describing what Franklin Roosevelt did in 1933.

    In reality he stole all the gold savings of the public (not just 43% of them) – leaving people with gold wedding rings, gold filings and lots and lots of government paper.

    He also ripped up the gold clauses in contracts in contracts – private ones and contracts with the government.

    When the Supreme Court (de facto) upheld all this in 1935 the American experiment with limited government effectively died.

    The Chief Justice of the Supreme Court "passed the buck" to the American people (hoping they would throw "FDR" out in 1936) – but as with Chief Justice Roberts and Obamacare, when the Supreme Court refuses to do its duty, the people tend to fail as well (they have hardly been set a good example).

    As for the Federal Reserve.

    Central Banks should not exist.

    And they do exist – they should do nothing.

    As the then Governor of the Bank of England replied to Walter "concede whatever it is safe to concede" Bagehot – commercial banks going bankrupt is nothing to do with the Bank of England.

    If there must be Central Banks (and there is no reason for them) then they should be headed by a Governor such as the man who replied to Walter Bagehot.

    As for the depression – for example MASS UNEMPLOMENT.

    The market was NOT ALLOWED to clear,

    The government (and government backed unions) refused to let real wages fall.

    It was not till World War II that real wages actually fell as they should have – for the labor market to clear.

    Real prices in World War II being "black market" prices of course.

  16. Finally someone wrote this piece. I always didn't understand people that loved tight money and people that loved loose money. Just learn to love the economics behind the monetary phenomena.

  17. One of my comments here (I have not checked the thread of Kurt S.) has still not appeared.

    The one that explained how even if there is no government debt (not just no deficit – no national debt at all) Pyramid Scheme banking (it is misleading to call it "fractional reserve banking" as such things as ninety tenths or 900 tenths of the actual PHYSICAL money, are not "fractions" as a normal person would use the word) we still lead to a boom-bust. Such as the one that blew up in Martin Van Buren's face – inherited from the "pet banks" that Andrew Jackson had favoured.

    It is true that these State level banks had constructed Pyramid Schemes on top of the tax money entrusted to them (which is why Martin Van Buren wished tax money to be kept from banks in future – to be physically held in an "Independent Treasury" and paid out as required by government spending), but commercial banks can still construct Pyramid Schemes (of various different kinds) even WITHOUT government tax money getting into their hands.

    As for "T. Bills" – they are simply government IOUs

    They can not, legitimately (not "legally" we all know who writes the laws), be used as a "reserve" or anything else.

    When someone lends money to an individual or company for (hopefully) productive investment one is engaging in an investment (and all investment involves RISK) – hopefully the productive investment will come off and the individual or company will be able to pay off their loan with the additional PROFITS created from sales from their new factory (or whatever).

    This is, I repeat, a RISK – one can not (legitimately) count individual or corporate debt paper as a "reserve" (a loan is NOT an asset) – it is an investment which may (or may not) pay off.

    However, when lends money to government (any level of government) one is doing something else – this is not an investment (as governments do not engage in productive activity), one has committed a corrupt act. What one has done is to engage in a conspiracy – become an associate in a Protection Racket. One lends money to the government now ("buys T. Bills") in the hope that the government will use force and fear in future to collect additional taxes in order to pay this debt (plus interest).

    This is not difficult to understand – but people do not seem to understand it. For example, when people "vote for a bond issue" at a local level they seem to believe they have provided "additional revenue" for the city or county government. They have NOT provided additional revenue for the city or county government – what they have done is to vote for HIGHER TAXES at a later date.

    But, as already stated, people do not seem to understand that have voted for HIGHER TAXES at a later date (to pay back the debt plus interest – in return for whatever, no doubt hopelessly corrupt, scheme the "bonds" have financed). Indeed the time to pay back the debt arrives they (or at least the officials and elected representatives) tend to call in Wall Street (to play complex games with the "bonds") – a fatal mistake as it massively increases the debt (the bankers and other such are interested in making money – they do not possess a magic wand to reduce debt, calling them in can only INCREASE the size of the problem).

    As for the Federal Reserve creating money in order to enable banks (and other such) to buy "Treasury Bills" (or buying them itself) that is best understood as a part of political corruption not a part of economics.

    Another version.

    Government (at all levels) should not borrow money. If people are not prepared to pay taxes to pay for some government scheme (say to invade some country somewhere) they do not REALLY want the scheme (because they are not prepared to pay for it).

    The Emperor Marcus Aurelius (the Commander in Chief of a state that lasted a lot longer than the modern credit bubble states of the modern West will) even sold the family jewels to set an example for people in the raising of resources to fight the barbarian invaders – as he drove them back from the fields and cities of Italy to the forests of Germany and Bohemia. He did not debase the coinage (turning once real gold and sliver coins into worthless tokens) still less "borrow money" that DOES NOT EXIST (that is a credit bubble – not an open sacrifice). Yet he managed to finance a life time of war against head-hunting barbarians (this was centuries before the Germanic tribes became Christians) who would have reduced all civilisation to ashes and dried blood. And he commanded himself (in spite of being in terrible pain from chronic health conditions) rather than posing for photo ops hundreds of miles from combat.

    I suspect that reading the Meditations of Marcus Aurelius (although it was not meant for publication) would do people more good than reading a lot of what passes for "economics". Such study would, hopefully, teach people that they can not have something for nothing – that there are no short cuts or easy fixes. That things that are really worth doing can only be achieved with intense effort – and at the cost of agony.

    Turning back….

    However, even if governments never borrow money (if there is no government debt – not just no deficits) Pyramid Scheme Banks (and other such) can still create boom-busts, although these will tend to be smaller boom-busts than if the government is involved.

  18. Yes Vange IV – the decline of the Chicago School is tragic. Rational Expectations was bad enough when applied to private individuals and companies (because it opened the door to ideas of perfect knowledge and error free business judgement, even if a Rational Expectations person does not formally have to go as far as that) – applied to government (especially democratic government) it is lunacy.

    Milton Friedman was a great man. I often disagree with Rothbardians (on everything from the Civil War to Korea), but I do not disagree with Rothbard in his summing up of Milton Friedman "great – on everything bar monetary policy and banking" (although that does tactifully overlook the problem with the education voucher idea in relation to the corruption of private schools by government money – and the far worse problem with the "negative income tax" idea which would lead to the same growth of an "underclass" that present welfare policies have led to) and, towards, the end of his life Milton Friedman (out of bitter experience over decades – and in many nations) came to the conclusion that governments simply could not be trusted with the task of "maintaining the money supply" (politics and just incompetence – made governments unfit for this task).

    However, the decline of the Chicago School really started with Milton Friedman.

    The ignoring of the problem of Pyramid Scheme banks (yes – in his early work Milton Friedman does note the problem, but then the problem seems to get forgotten….) a general Legal Positivism seems to grow in his thinking – if the government law says X then X is right (yet in such things as occupational licensing it is NOT right according to Milton Friedman – so there is some split mindedness here).

    Even in his autobiography (with Rose Friedman) Milton Friedman waxes indigent about the former Governor of New Hampshire (Governor M. Thompson) forbidding his (Friedman's) daughter crossing his land to get the mountains in New Hampshire (meaning the young lady had to walk a longer distance) – did not Mr Thompson know that "Federal regulations" mean he has no right to not allow the young lady to cross his property! Declares Milton Friedman – thinking he is discrediting Thompson and, actually, discrediting himself.

    "Relevance Paul, relevance?"

    Legal Positivism rarely (if ever) exists in isolation – it normally comes with other forms of Positivism.

    And sure enough we see Positivism in Milton Friedman's theoretical work – for example in his Essays on Positive Economics.

    So what if a theory does not make sense – as long as it predicts accurately…..

    So what if a theory does not make sense? So what if one rejects human reason and logic?

    And, no surprise, theories that reject reason (that do not make sense) do not really "predict accurately" anyway.

    For example, Irving Fisher (whom Milton Friedman repeatedly called the greatest American economist of the 20th century) utterly failed to predict the crash of 1920-1 or that of 1929.

    He could not see anything bad coming (he could not really see it – even after it hit). This was because his theories (by rejecting reason) left him blind to the real world.

    And one must be very careful by what one means by the "real world".

    There is the real world of politics and academia – and there is the real world of understanding the economy (and they are not the same thing).

    For example, George Selgin has suffered from being outside the mainstream (I do not deny that he has suffered) – if he was further outside the mainstream he would suffer more (for example he would not have an academic job) is it reasonable to ask George Selgin to destroy his life, and he life of his family, in this way? After all it would do not good – he would lose what (limited) influence he has with government and bankers, the sacrifice would be for nothing……

    Milton Friedman has a life of high academic prestige (ending up the so called "Nobel" Prize in 1976) he was an adviser to many Presidents – trying to do what good he could. And sincerely trying to do what good he could.

    Had he been as outside the mainstream as we are he would have spent his life sweeping the streets (or some such job). Again the sacrifice (the terrible suffering) would be for nothing, indeed less than nothing – because it would close the door to the possibility of doing any good….

    Would it have been reasonable to ask Milton Friedman to take that path?

    Later members of the Chicago School have just taken this logic (the logic that it is not reasonable to totally destroy one's own life by being radically outside the mainstream)some steps further than Milton Friedman did.


  19. George in your article you refer to the Austrian Theory of Business Cycle as one in which total output is not what changes, but allocation of capital within said output. That is to say, not a theory of overproduction but misallocation. Have you read Roger Garrison's recent papers on ABCT (Here: (, in which he proposes, more or less, that the malinvestment cycle is also an overproduction cycle? If so, what do you think of it?

  20. Let's assume that there is a country which has both a matured and competitive free banking system and that the monetary standard here is a fiat un-backed money which is spent into existence (on infrastructure or whatever) and then deposited as base money, off of which the banks would issue credit. By this monetary system the issue of money does not directly influence the supply of loanable funds and so doesn't macroeconomically 'tamper'. The only effect of note issue here is redistribution of purchasing power from later recipients (of the money) to earlier recipients and also slightly cheapened debts.

    Let's assume further the unrealistic situation that for a number of years, banks expanded credit without the assistance of a monetary authority such that the market rate was beneath the natural rate and capital was grossly misallocated. After this boom, the market rate returns to the natural one and a bust ensues.

    When this bust precipitates, and companies go bankrupt and confidence in the banking sector is shaken, would you expect that banks could lower their reserve ratios such that, despite several bank failures, the money supply is not contracted very much and things carry on as normal soon enough? Or that, in order for the money supply to not 'snapback' farther than is necessary for all malinvestments to clear, the monetary authority ought to spend some money into the economy?

    I remember reading your article which came out mildly in favor of the first QE, which confused me, since you are aware of Austrian Capital Theory. I thought that you should appreciate how OMO's would further prop up malinvestments, but you made the point that if we assumed Free Banking during a recessionary period, there's no reason to expect that the banks would simply contract credit themselves and that, in fact, the reason why they hadn't expanded note issue (for example: notes to nervous depositors who want, not necessarily the gold currency, but the means-of-payment stored at their bank) was because they were prohibited from doing so. So I'm interested in your thoughts as to whether you think that, given Free Banking (private and plural note issue), the private banks would be able to expand note issue so that money supply fell only inasmuch as was necessary to clear malinvestments and no further? Or if you think that there cases imaginable which, even under a free banking scenario, might call for a unilateral expansion of money supply.

    Also, could you check out my thread here and possibly offer some commentary/criticism:

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