Arnold Kling  

Brad DeLong's Dangerous Modeling

The Ahistoricity of the SIVH... The Power of Productivity...

From a short paper he calls Picking up Nickels:

The more speculators ex ante expect bailouts and the more speculators are impressed with their own cleverness, the more hesitant should the central bank be about providing monetary accommodation.

The paper comes very close to giving an Austrian account of business cycles, with part of the process consisting of the monetary authority keeping interest rates too low for too long. The paper comes close to saying that government bank policy creates moral hazard with adverse consequences. The paper comes close to saying that there is a major time inconsistency problem with bailouts--the incentive to bail out is stronger ex post than ex ante.The paper comes very close (more than close) to saying that we would be better off if the monetary authority did not try to eliminate all cyclical unemployment.

A little modeling can be a dangerous thing. Thanks to Mark Thoma for the pointer.

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COMMENTS (14 to date)
Daniel Kuehn writes:

Why is it that people think that "keeping interest rates too low creates bubbles" is an Austrian idea??????

Daniel Kuehn writes:

I mean - it IS an idea that Austrian economics hold, but simply agreeing with that very fundamental point is in no way an embrace of Austrian business cycle theory.

Austrians believe in the law of supply and demand too. Am I supporting Austrian economics by believing that too?

E. Barandiaran writes:

Arnold, the idea that the incentive to bail out is MUCH stronger ex post than ex ante has been known for many years (I argued it at the time of Chile's banking crisis of 1982-83). And the solution is quite simple: since all (democratic and dictatorial) governments are going to intervene ex post, then it's better to have ex ante a mechanism that will be in charge of bailing out discretionarily some creditors while punishing severely any one (managers and owners of banks and other financial companies) that has intermeditated the funds invested by these creditors. You have a moral hazard problem only if those intermediaries are not punished.

Ryan Vann writes:


It isn't so much the idea, that interest rates below market clearing rates cause misinformation and thus malinvestment, is an Austrian original concept, but that they have championed the idea despite adversarial opinions and attacks for many years.

For a guy like Delong, who has been historically anti-Austrian, to come out and essentially utilize an Austrian approach is quite newsworthy (he even uses time-structure arguments).

fundamentalist writes:

Ryan, I agree. Hayek and Mises repeatedly wrote that they did not invent the monetary theory of business cycles. Hayek credited Richard Cantillon for starting the ball rolling in the early 1700's. Mises credited the currency school of Manchester.

The big difference was that in the 1930's mainstream econ decided to abandon the monetary theory of business cycles and in fact exclude money a priori as a cause of business cycles. Mises speculated that the reason was to prevent the total destruction of socialist theory.

Since the 1930's, Austrians have been the sole promoters of the monetary theory of business cycles. So yes, if you even suspect that manipulation of the money supply at least contributes to business cycles, then you are subscribing to Austrian economics.

baconbacon writes:

"Why is it that people think that "keeping interest rates too low creates bubbles" is an Austrian idea??????"

One major conclusion of the Austrian Business Cycle Theory (ABCT) is that the government cannot mitigate the damage of the bubble without creating another bubble in its place. Look at Delong's quote closely and think about how bailouts will influence the future actions of those receiving (or noting who else received) them.

Floccina writes:

The way I see it the monetary system is not robust to failure. The beauty of Economic freedom is that it produces good overall results despite the fact that people are often myopic, stupid, greedy and selfish. The USA monetary system did not evolve but was instituted by government and is a monopoly system. It is not robust to the failure of finical institutions. It would be much better if the system was such that the failure of one financial institution (due to stupidity, greed and selfishness) would make all the others stronger rather than weaker but rather the current system has bad negative free backs. With the current system the failure of one institution is contractionery and thus weakens other institutions.

It is also weak because it is controlled, although indirectly by the median voter even tough the median votes does know how the system works.

Anything that can go wrong will eventually go wrong and a monopoly bank like the federal reserve can go badly wrong. I have heard people say that due to design it is impossible for a nuclear power plant to blowup, we need such a banking system.

I think that Scottish free banking was evolving toward a robust system without negative feedbacks. I do not know enough to say for sure but having the Federal reserve broken up into competing banks with competing currencies might help us to mimic free banking.

fundamentalist writes:

It has taken mainstream econ just 80 years to catch up to Mises and Hayek!

q writes:

that's great. so why don't you do the same thing? a simple model might just allow your ideas to be tested!

Schaeffer writes:

that's great. so why don't you do the same thing? a simple model might just allow your ideas to be tested!

Um no. You need more than just a simple model - you need controlled experiments to truly test hypotheses.

Justin P writes:

"Why is it that people think that "keeping interest rates too low creates bubbles" is an Austrian idea?"
Because it is the central thesis of Austrian Business Cycle Theory.
We can all agree that the accounting identity Y = C + I + G + NX is true without being Keynesians but when we start talking about G and how increases in it can lead to higher Y, that is explicitly Keynesian econ. Delong is admitting the equivalent of Mises arguing for more G!

Personally I really don't think DeLong has even read Mises or Hayek, judging by his posts, I know you haven't read Human Action, you've admitted that much to me at cafehayek. Delong could think he has discovered something on his own, unaware that he just stumbled on Austrian Econ that he and Krugman have belittled for years.

Donald A Coffin writes:

So let's rank the alternatives, according to DeLong:

Best: Speculators do not expect to be bailed out, and the Fed bails out the economy after a crash. Described by Kindleberger (and DeLong) highly unlikely to be able to happen.

Second best: Speculators expect to be bailed out and are.

Worst: Speculators expect to be bailed out and are not.

Or did I miss something? (No.)

Ryan Vann writes:

On the topic of ole Bradford; I recently caught a debate he had with Michele Boldrin. Somewhere during the debate he said something to the extent that the Great Depression was over in 37, but FDR cut fiscal stimulus, and a consequent recession began.

Now perhaps the two of us have varying beliefs of what entails recovering from a recession, but if fiscal stimuli must be maintained indefinitely to keep up production levels, how can that be interpreted as fixing the underlying problems? In other words, while it may be true that fiscal stimulus increases output in a tautological sense, that doesn't imply that it returns an economy to trend.

Eric H writes:


It's funny how easily DeLong slings around the term "right wing;" and it's also funny that he cites Hoover's autobiography for his argument.

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