« Capital-biased technical change vs low interest rates? | Main | Triangles, rectangles, trapezoids, stripes, and gaps. »


Feed You can follow this conversation by subscribing to the comment feed for this post.

No, an Ad Hominem would be to say that Hayek is theoretically correct but is still wrong because he's a P**-P** Head.

Saying that Austrians were wrong and Hayek was right is intriguing but I don't see any logical fallacy.

However Greg Ransom is likely having a stiff drink and a lie down on the couch right now.

"Hayek is theoretically correct but is still wrong because he's a P**-P** Head."

My wife saw a clip of him on Firing Line and declared him "cute as a turtle"!


You teach for a living and so most (all?) of your income is derived from a teaching salary. And and as you say, suppose you spend all of that income on old sports cars. Now suppose someone out there is the polar opposite of you, they fix up old sports cars (deriving most of their income from it) and spending most of their money on college economics courses.

What happens when a monetary injection is directed at either you or your polar opposite? That money will tend to circulate between the two of you without reaching other economic activities. Hence, the initial injection of money creates a permanent change in the relative prices of economics courses and old sports cars relative to all other economic goods.

You also mentioned credit, but here is the thing - the credit markets are not a homogenous one interest rate market (despite what you read in text books :-) ). And so just because you (or your polar opposite) put your money in a bank does not mean that you are getting a reasonable return on your money OR that a borrower is getting a reasonable cost of money.

By introducing a bank you add a third party to the equation that may not care much for college economics courses or old sports cars.

"Hayek is theoretically correct but is still wrong because he's a P**-P** Head."

My wife saw a clip of him on Firing Line and declared him "cute as a turtle"

You are driving on a highway in Auburn, Alabama, home of Auburn University and a seat of Austrian economics. You see a sign.

Caution: Austrian Economist Crossing.

Here's a thought of what happens next. Though this is generated by a "fiscal" act and uses sticky wages (not goods prices) as the causal mechanism.
“The Cantillon Effect of Money Injection Through Deficit Spending”; Cheng and Angus; December 2012.


You say: "Newly-printed money can be injected anywhere in the economy. It might be spent on bonds. But it might instead be spent on tanks"

No, it may not be. With some rare exception, newly printed money can be spent only on bonds("bonds" here stands for CB approved collateral).

Determinant: I think (not sure) that Greg might like this post.

Gene: I had to smile at that. He did have that rather cute turtlish look!

gofx: thanks. I will try to have a look.

Госбанк: even if the government mails out cheques, drawn on the central bank?

Hayek talks about the endogenous growth of money in his 1929 Monetary Theory and the Trade Cycle.

The getting and lending of money feeds on itself in a private marginal reserve banking system in ways connected to production processes and consumption markets with far off time elements. In other words, no central bank is needed to create a Hayekian monetary trade cycle.

What you are describing here is (potentially) part of how that process can be nudged or leaned on in a manner changing interest rates and (potentially) set a little unsustainable snowball rolling -- perhaps making people think that more savings is being withheld from consumption than actually is being withheld. (You are only temporarily delaying massive consumption, when you suddenly demand goods that don't require long term production processes, it is possible others were mislead to initiate long term production processes because of the low interest rate and the availability of loan money, production process for which you will have no resources to demand at prices sufficient to cover costs.)

But it depends on our assumptions. It's a toy model. We can assume that savings pretty much remains in a stable flow across time with long term investment coordinated with consumption across time, or very quickly comes back to a non-fluxing flow closer to such a stable system.

In other words, by assumption we can pretend that money finds its way into savings and then into investment with no Keynesian hitch, and savings preferences across time are not out of line with consumption preferences across time.

Nick writes,

"I'm going to defend Hayek against the Austrians.

Suppose the government gives me $1 billion in newly-printed notes. The helicopter only flies over my house. (That is equivalent to the central bank buying $1 billion in government bonds, plus the government selling $1 billion in government bonds to give me a transfer payment of $1 billion. I would say we can analyse those two operations).

I'm richer. We can expect to see an impact on the markets for old sports cars and new canoes. It would probably be different if you got the $1 billion instead of me.

But what do I do immediately with that $1 billion in freshly-printed notes? I go to the bank, and deposit them, or most of them, in my account. I lend the bank $1 billion. That $1 billion in base money enters the credit market just as surely as if the central bank had lent my bank an extra $1 billion.

Even if I didn't do that, and instead paid cash for $1 billion worth of old sports cars, the sellers of those cars don't want to hold the cash either. They deposit it in their banks. They lend $1 billion to their banks. Again, that $1 billion in base money enters the credit market just as surely as if the central bank had lent an extra $1 billion to their banks or bought $1 billion worth of bonds.

We don't want to hold an extra $1 billion in base money. So we lend it. Or most of it. Or try to lend it, by pushing down interest rates. It enters the credit market.

OK Hayek, over to you. What happens next?"

Determinant -- this just keeps me up and off the bed where I'd much like to be resting my bad back.

I am a strong believer in the importance of a conversational community for the advance of science and the humanities more generally, a lesson I picked up in part from philosopher of science & explanation Larry Wright as he helped me appreciate Kuhn, Wittgenstein, and his own work.

Nick is great at conversation.

Thinking through this stuff "out loud" makes me understand it better, and as I write my unpublished work, it gets better, more conversational, with more explanatory power for any kind of reader.

A good conversation calls for a beer or a glass of wine, not a stiff drink.

"Hayek assumed that newly-printed money is injected via the credit market"

Hayek assumes money and credit can be disturbed of expanded and contracted in many different ways.

Hayek is not Murray Rothbard. The picture of "Austrian Business Cycle Theory" usually comes from folks who were Rothbard groupies as teens. Hayek never assumed the real world was a toy model.

I doubt you can find the word "injected" in reference to money anywhere in Hayek's collected works.

Hayek in the first instance thinks about the expansion of money and credit as an endogenous process without central banking.

And then there are all kinds of things besides Open Market Operations by the Federal Reserve that Hayek has in his mind when he thinks about monetary policy -- eg the purchase or sale of foreign currencies or gold and the balance between gold and gold-exchange currencies and the US dollar was a big deal for Hayek's thinking about what was happening with the Austrian Krone and other currencies after WWI. And this is directly related to long term sustainable or unsustainable spending and borrowing and debt policies by government entities. A long running Hayek theme is the chaotic and dangerous connection between monetary policy or expectations and unsustainable national accounts.

You can see all of those theme in *Monetary Nationalism and International Stability*.

The only closed economy Hayek assumes is one for modeling purposes. When he talks about the real world, he sees a loose-jointed network of international monetary regimes and forces impinging on one another.

I dunno Nick, there is something fishy in this post. You agree that a doubling of the money stock won't *permanently* reduce the rate of interest, right? So why wouldn't a helicopter drop just put us in that new equilibrium right away? Why would there be a transition period with a lower interest rate?

Here's a classic "Austrian" account from Mark Skousen of one mechanism at work in the 1920s:

"Austrian economists, such as Ludwig von Mises and F. A. Hayek, and the American sound-money school, led by Benjamin Anderson and H. Parker Willis, recognized that the fractional-reserve, fixed-exchange gold standard was a recipe for disaster. They predicted an eventual economic crisis under the gold exchange standard.

Monetary troubles worsened when, in 1925, Britain made the fateful error of pegging the pound at the exchange rate that prevailed before World War I at $4.86, clearly an artificially high rate. As a result, Britain suffered a deflationary depression for the rest of the 1920s. Moreover, to help Britain return to gold at the prewar exchange level, the Federal Reserve pushed down interest rates in 1924 and 1927, igniting a fateful inflationary boom in the U.S."


Rothbard gets a but further into the weeds (Rothbard history is richer than Rothbard fan-boy accounts of ABCT).

"After generating the 1927 inflation, the New York Federal Reserve Bank, for the next two years, bought heavily in prime commercial bills of foreign countries, bills endorsed by foreign central banks. The purpose was to bolster foreign currencies, and to prevent an inflow of gold to the United States. The New York Bank frankly described its policy as follows:

'We sought to support exchanges by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe's power to buy our exports.'

Those decisions were taken by the New York Reserve Bank alone, and the foreign bills were then distributed pro rata to the other Reserve Banks.[37]

While the New York Reserve Bank was the main generator of inflation and cheap credit, the Treasury also did its part. As early as March 1927, Secretary Mellon assured everyone that "an abundant supply of easy money" was available—and in January 1928, the Treasury announced that it would refund a 4? percent Liberty Bond issue, falling due in September, into 3? percent notes."


The general claim is that productivity (superior output at reduced input cost) was not allowed to drive down prices in an equilibrium producing process due to expansion made possible by international money operations, not closed economy "injections".

If the helicopter flew over your house, Nick, and those of several thousand like-minded people, then an asset bubble would soon develop in canoes, since I'm sure you only want the best, made-in-Canada, out of fine and rare materials. You and your friends would pay prices well above what may have been considered normal a year ago to acquire the fine canoes that you crave. Then the rest of the public would pile on, noticing that "the price of canoes always goes up." People would bid on canoes under construction, knowing that they could assign ownership on a quick flip deal for a profit. The Canadian government would, of course, encourage this economy-reviving growth in the domestic canoe industry by guaranteeing the low-interest loans of any and all who would care to borrow money to purchase a canoe. Household debt would soar, but nobody would be concerned because as long as you have a canoe in the back yard you can count on its increasing value to outpace your interest payments. Heck, you can use all that available leverage to buy a few of them and fund your retirement.

What could possibly go wrong?

Bob: Pouring a bucket of water into the bath tub does not increase the rate at which the water level rises permanently, does it? Nevertheless, the rate has to change temporarily just to achieve a new equilibrium.

Bob: "I dunno Nick, there is something fishy in this post. You agree that a doubling of the money stock won't *permanently* reduce the rate of interest, right? So why wouldn't a helicopter drop just put us in that new equilibrium right away? Why would there be a transition period with a lower interest rate?"

Nail on head. My answer is: sticky prices. I can never figure out what the Austrian answer is.


"even if the government mails out cheques, drawn on the central bank?"

The check will bounce assuming the treasury account at the feds is at zero -- an unlikely event admittedly, the account being replenished in the usual ways like taxes or bond sales. Not sure where this government printing idea comes from. MMT ? The US is not Zimbabwe, yet, thanks God.

Госбанк: The Bank of Canada decides how much money to print. It also hands over all its revenue from printing money (minus the costs of paper ink and economists) to its owner, the government. So if the Bank of Canada decides to print more money the government decides where to spend it.

Nick, the Austrian answer is stocks vs flows--it's the subsistence fund, or at least the figurative one. Stores drain down because the activity is indistinguishable from normal volatility that is smoothed by having n-days of supply stockpiled. Eventually, the increase in activity is seen as persistent (inventories go lower). At that time, prices rise, active slows back down and then we are in the new equilibrium.

Now you can call that sticky prices, but in doing so you miss the story of the mechanics of why prices have inertia.


BoC is not so different from the feds. BoC's "revenue" from printing money is bond interest payments leftover that it does indeed remits to the government(gov pays interest to BoC, BoC pays what's left after covering for expenses back to the gov).

BoC can "print" more money almost exclusively through its OMOs, i.e. buying gov securities in the open market. There is some small backdoor through which the Canadian gov can borrow directly from BoC, in exceptional cases, Zimbabwe like, as I recall, but the borrowing facility contribution to printing is about zero in practical sense.

There is no such backdoor in the feds' case.

Exactly. But the best way to inject the money without using credit markets is to pay government salaries with cash instead of chacks, but then don't actually adjust the amount of government spending or taxes. Then there are no fiscal effects (as traditionally defined), no distribution of income effects, and the money is not injected via the credit markets. Still in a bit more than a nanosecond the cash goes into banks reserves.

Much of the Cantillon effect argument is just people not thinking clearly.

Greg Ransom:

I am unsure that Austrian claims about the downside of Central Banking and the business cycle can be justified in the face of a clear counterfactual: Canada.

The Bank of Canada did not exist until 1937. Before then all Canada had were the private chartered banks, the same ones you see now (a few more because four partners hadn't merged into two yet). The Government defined what a dollar was (legally in terms of gold) and minted gold at the Royal Canadian Mint in Ottawa, but bank notes were just that, demand notes drawn on the chartered banks. That was what was in people's wallets.

But bank notes didn't really compete. In order to have a functioning exchange system everyone accepted the Big Ten (now Big Five through mergers) at par and nobody else's were considered or accepted. People very quickly adopted a uniform standard with no actual evidence of ongoing competition in bank notes.

That system even grew its own Central Bank, the Bank of Montreal. The BMO is the oldest bank in Canada (1817) and served the commercial centre of the country in Montreal, until the 1880's Canada's only real city (Toronto took longer to develop). The Province of Canada used the BMO as its fiscal agent starting in 1854, they handled government payments and assets. This gave the BMO heft and it also had a customary duty to step in and provide liquidity when needed, to ensure a working market and to lead bailouts of weak banks. Bankers themselves wanted to contain bank runs as banking is a business based on trust. The usual solution to weak banks was to arrange a shotgun wedding with a stronger bank.

This free-market system did nothing to prevent or ameliorate the repeated boom and bust cycle of the 19th Century, the Long Depression was particularly grinding in Canada. It did nothing to prevent or lessen the Great Depression, which affected as bad as it did the US. We didn't have any bank insolvencies in the Depression but it didn't relieve our suffering.

I thus fail to see how the presence or absence of a Central Bank can be used to explain the Great Depression.

"$1 billion worth of old sports cars"

The problem with this examples is that old sports cars are like collectable works of fine art.

They act as stores of value and potentially liquid assets.

They are in some ways like buying gold.

I neglected or blew over this aspect of the problem, which isn't insignificant.

"$1 billion worth of old sports cars"

What we are adding to is the stock of variably liquid stores of value which are substitutes money, and can be used to back borrowing either for investment in production processes, or which can be borrowed against for purchasing back rubs.

It matters for thinking about this which effect is assumed.

And another thing we can stipulate as a 'given' is whether these old cars are purchased as a place to store value, and perhaps borrow against, or are they purchased to wreck in a demolition derby.

The specification of such "givens" actual matters to the implications of the model.

Leaving such things unspecified allows the model as the foundation for conversations at cross purposes.

"$1 billion worth of old sports cars"

The implications of the toy model change if we assume these are easily manufactured replicas of old sports cars.


Canada didn't have branch banking laws.

American laws against branch banking famously created a fragile banking system due to the agriculture cycle.

Smoot-Hawley helped crash the American banking systems, via first crashing US agricultural experts, then putting banks linked to that trade into insolvency.

Canada is evidence for Hayek insights about money and banking, as many Hayek influenced economists have explained.

Determinant, you'll have to argue Canandian vs US banking with George Selgin or Lawrence White or some such.

I don't pretend to have special expertise in the history of banking.

Scott Sumner writes,

"Much of the Cantillon effect argument is just people not thinking clearly."

I continue to suggest that "much of the Cantillon effect argument" is an argument that nobody has made but Scott Sumner.

Nail on head. My answer is: sticky prices. I can never figure out what the Austrian answer is.

Nahhh, I think you're doing something really fishy here too Nick. You're saying upfront in your post, "A helicopter drop has the same effect as injecting money through the credit market, and so the Austrians are wrong."

Then I challenge you as to why you think this is true, and you say, "Because of sticky prices, but Austrians don't like that mechanism, so I don't understand why they think a helicopter drop has the same effect as injecting money through the credit market."

Do you see what I'm saying? There's no inconsistency in my view, as far as I can tell. You are changing one of my beliefs, then wondering why that altered belief is inconsistent with another of my (actual) beliefs.

Jon and Bob: so, are you guys telling me that Hayek ripped off Lucas '72 to create ABCT? (Joke.) Is it about people confusing real vs nominal price changes? Because if so, you can tell the same story with helicopter money. People don't know the helicopter has flown over everyone. My canoe manufacturer thinks it just got lucky, and hit by a real shock, so expands production. It doesn't know that demand has increased across the whole economy.

"Because of sticky prices, but Austrians don't like that mechanism...."

Hayek was fine with the sticky prices mechanism and talks about it in several places.

The mechanism is not original with Keynes.

Nick writes,

"Hayek assumed that newly-printed money is injected via the credit market"

Hayek assumed that a fractional reserve banking system can create endogenous purchasing power -- before the time of consumer credit this typically would be all about firms loaning deposits to banks and banks loaning money to firms for expanding production and firms spending money which goes back into banks as those who earn the money again loan deposits to the banks, rinse, lather & repeat.

The expansion and snowballing of money and credit and investment can also come via other processes.

More Nick,

New money injected via the credit market, "pushes down the market rate of interest relative to the natural rate of interest."

In Hayek there are all sorts of factors that can be part of the process of 'pushing down" market rates of interest relative to natural rates of interest.

One mechanism is a snowballing wave of heightened optimism and lowered risk expectations where firms are loaning deposits to banks and banks are loaning money to firms for expanding production and firms spending money which goes back into banks as those who earn the money again loan deposits to the banks -- and all of this is done in anticipation of lower input prices than future scarcities will allow for extensions of the length of production which never existed before.

All sorts of different policies and actions by central banks and central governments can give this snowball assisting pushes of momentum or can do what is necessary to eliminate slowing hills in the road.

Nick writes,

"and this causes people's plans and expectations to be mutually inconsistent"

The knowledge problem makes is all but impossible to perfectly coordinated streams of never before combinations of inputs involving new technologies and consumed non-permanent production goods which will never be reproduced again.

These plans and expectations can never be perfectly mutually inconsistent -- and there is a knowledge problem degree of freedom allowing for snowballing dead-end streams which have no prospect of completion (due to the time delay of what will be changed input scarcity signals).

Nick writes,

"and this causes an unsustainable change in the time-structure of production"

Well, there isn't really any independent space between inconsistent plans and expectations and unsustainable changes in the time-structure of production.

There are intertwined and essentially one and the same.

Nick, I understand what you're saying about Lucas, and I don't know what answer to give you. I imagine you would see a bunch of different explanations given, if you read Mises, Hayek, Haberler, Rothbard, etc. on the business cycle. And since they would be doing it in words, not a formal model, it would be hard to put our finger on exactly what the claim was.

Another major problem in interpreting your post (and I think Greg was getting at this, above), is that you are talking in terms of the Fed doing stuff. But the original exposition involves the banks inflating because of fractional-reserve banking. So when you say, "Even if the Fed buys tanks instead of bonds, wouldn't that still get deposited and lower the rate of interest?" it's hard for me to answer your question in a classic Misesian framework. I think the answer is probably "yes," but you haven't thereby blown up the standard exposition. The *reason* the answer is yes, is that even if the Fed buys tanks by creating new reserves, the commercial banks still end up inflating through the credit channel when they issue new loans on the basis of those new reserves.

In other words, you haven't shown that "it doesn't matter where the new money enters the economy, we still get ABCT." Instead you've shown, "In a system of central bank plus FRB, it doesn't matter that much where the initial reserves enter the economy, because the bulk of new money creation will still enter through the credit channel."

But if we had fiat money with 100%-reserve commercial banks, then I think it is still true that a helicopter drop doesn't cause a boom-bust cycle, whereas printing up new money over the course of two years, and getting it into circulation solely by lending it to borrowers, *will* cause a boom-bust cycle.

Of course, this should read:

These plans and expectations can never be perfectly mutually *consistent* -- and there is a knowledge problem degree of freedom allowing for snowballing dead-end streams which have no prospect of completion (due to the time delay of what will be changed input scarcity signals).

Bob: assume no commercial banks. Suppose there's a flow of helicopters for 2 years, wouldn't people want to lend out a large part of that flow of new money? Wouldn't we still get a boom and bust? (You don't need banks for lending.)

I really wish you guys would just start really simple.

Nick, not nearly as much as if the new money ALL came through the loan market, right?

I mean look, it's like I say:

BOB: It will make a big difference in relative prices if we have a helicopter drop of $1 trillion per year for 2 years, versus someone with a printing press buying $1 trillion per year worth of real estate in Las Vegas. The latter policy will drastically alter real estate prices versus other assets, but in particular the Las Vegas market versus others.

NICK: Huh? If there were a helicopter drop, wouldn't some of the people spend that new money on real estate in Vegas? It's the same thing.

Nick, have I fairly summarized our argument above? If so, can you see why I'm not losing sleep at night over this?

Bob, isn't the hidden premise assumed by Nick etc simply that no one with a printing press would spend $1 trillion per year on real estate in Las Vegas?

I think the fundamental road block here is an inability to see the possibility of price signals fooling people or for price signals to be systematically incompatible across time.

Let me try this.

It's easier to see if you look at economic activity as a one-directional flow of alternative streams flowing in and out of each other toward an unknowable future, rather than looking at economic activity as a perfectly known and perfectly coordination always identically repeating equilibrium circular flow.

I think people can't get past the image they have from the textbook that textbook equilibrium math constructs perfectly capture just exactly what price signals are. They are the kind of thing that people can't make mistakes with, unless there is some outside 'shock' intervening to do it, like a Federal Reserve instantly and magically evaporating a huge chunk of the money supply and sticky prices then causing systematic discoordination. Price signal discoordination cannot be internal to the system (as Hayek and Mises hold) simply because the model scheme suggests that it cannot, without an "outside" cause, like Fed action and sticky prices.

Think about the possibility of dead-end streams resulting from collections of bad and reinforcing judgments when I say that it is easier to systematic discoordination if you look at economic activity as a one-directional flow of alternative streams flowing in and out of each other toward an unknowable future.

Bernard Madoff is an example of this. There were imperfections in peoples knowledge, and there was a systematic false signal -- all sorts of people getting rich because of investing with Madoff. That signal could not have been sent unless there was a snowballing collection of erroneous and reinforcing judgments -- Madoff needed an every expanding pile of investment cash to continue to transmit his false signals.

Note well.

This went of for years and years.

Nick, what if the banks don't lend the money, but instead pay it to their executives... who deposit it back in the bank, which pays it to their executives... who deposit it in the bank, which pays it to their executives...

Greg Random is correct. You have failed to consider dead-end money flows. These happen frequently among the extremely rich elite, the 0.1%.

There's another fundamental error, or perhaps the same one in a different guise. Nick, have you heard of the velocity of money?

Inject the money in one place (pay the homeless!), its velocity is high.

Inject it in another place (bailouts for zombie banks!), its velocity is very low.

So, different multipliers.

Stocks vs. flows mistake, perhaps?

With Hayek and 'streams' toward and unknown future you get path dependence.

With the picture of perfect and instant 'general equilibrium' built out of 'givens' you can't even imagine path dependence.

Most economists can imagine only 'sticky prices' as the path dependent bump in the road to perfect and instant coordination.

Booms & busts raise a 'how possible' problem to be answered, economists can't answer it because path dependence isn't possible in the math.

With path dependence impossible by assumption, economists imagine 'shocks' & 'sticky prices' as only bumps in road to instant coordination.

The mathematics used by economists necessarily eliminates by assumption the path dependent phenomena which makes boom & bust cycle possible.

Economists can't imagine Hayek's maco mechanism because they can't imagine path dependence, their perfectly balanced math doesn't allow it.

Hayek talks of economic production as an interlaced multitude of rising & falling & some times dead end streams towards an unknown future.

n Hayek's economics & in real world there is path dependent discoordination. In textbook econ there are ad hoc 'shocks' & 'sticky prices'.

Just brainstorming explanations for the fact that macroeconomists literally can see Hayek's explanatory mechanism -- cross paradigm phenomena described at length by Thomas Kuhn.

I've found were Hayek does talk of the "injection" of money and it is clear that Hayek is talking about the point where the increasing supply of money is moving from the banking system and into business loans used to finance extensions in production. Hayek is not talking about where money is expanding, he's talking about where it flows after it has expanded.

Hayek is taking it for granted that the money supply is expanding and it is finding its way into business loans for extending production, as part of a process where money used as loans for investment are outstripping savings choices and sustainable savings and consumption preferences across time.

The comments to this entry are closed.

Search this site

  • Google

Blog powered by Typepad