Tuesday, November 11, 2008

Why Government Spending Programs Won't Cure the Recession

This is quickly becoming Bob Murphy week at EPJ.

Bob has a great piece at mises.org today where he uses the new Nobel laureate, Paul Krugman, as a punching bag to explain why Keynesian spending programs to fight a recession are way off base. He also simultaneously blows apart the static mainstream circular flow model. It is must reading.

Probably because he was too exhausted from all the punches he was throwing, he did allow Krugman to get away with one piece of Krugman/mainstream mis-categorization that is a pet peeve of mine.

Bob quotes Krugman as writing:

The long-feared capitulation of American consumers has arrived…[R]eal consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent.

My quibble with Krugman here is that he points out that the real drop in "consumer" spending is in the durable goods sector. Since the Austrian Business Cycle Theory (ABCT) states that a downturn is about individuals re-establishing old savings/consumption ratios in favor of consumption, the decline in "consumer" spending has to be confusing to many of those trying to grasp the nuances of ABCT.

If ABCT is about consumers re-establishing stronger consumption patterns, then why is the consumption Krugman points to going down? The answer to the seeming paradox is that most of what Krugman is pointing to is not consumption, but saving.

Consumption is exactly that, consuming now, savings is about consuming later. If you rent an apartment, you are consuming now. If you buy a hamburger and eat it, you are consuming now. If you go to a movie, you are consuming now. If you buy a house, you are saving in the sense that you are acquiring an item that will result in saving for future consumption, in addition to a small amount for immediate consumption. The error of many economists is that they look at a physical good, such as a car or television and label it a consumption good. A good should only be defined by the purpose a good is being used for. If you are Elvis Presley like and you plan to shoot your television in the very near term, you have pretty close to a 100% consumption good. If, however, you plan on viewing shows on your television for the next 10 years, then you have purchased a good that is a small part immediate consumption good, but for the most part it is a capital good that will only provide consumption value in the future. Thus, "durable" consumer goods are really capital goods. It is not surprising that their sales should drop during a downturn, since the same financing that provides for such goods is the same financing that provides the boom in other capital goods sectors such as factory equipment, and which is now causing the downturn.

Note: This is a blog post and not a dissertation so I am not covering all the intricacies of a downturn, but I hasten to add that a downturn in an economy sometimes results in an increasing demand to hold cash balances, which creates an overall downward pressure on prices. This can appear to be a slowdown in consumer sales, when in fact it may be an across the board re-adjustment to a new general lower price level.


  1. I think you will find that this is the Bob Murphy Decade. Krugman + Obama = golden opportunity.

  2. Oh yeah,

    This will be our decade, especially
    when we end up in detention camps.