Wednesday, December 8, 2010

What John Carney Needs to Read Right Now

John Carney has been a good friend to Austrian economists, and he has good gut instincts as to the reasons the government should stay out of the economy. But, he still needs to do more reading about the Austrian business cycle. I cringed  when I saw this by Carney:
Earlier today I pointed out that personal finance website Smart Money was urging people to save rather than spend the extra income they’ll get from the temporary payroll tax cut. My point was to say that this could undermine the hopes of the Obama administration that the tax cut will create stimulus for the economy.


Based on Austrian thinking about the economy, this is totally 100% wrong. Your thinking is totally Keynesian here.

What goes on during the boom period of the business cycle is that central banks prints money and direct it into the capital goods area of the economy, i.e. more investment takes place then would occur without central bank intervention. In other words, the savings/consumption ratio is distorted in favor of savings. When a central bank stops printing, the savings/consumption ratio starts to move back to its old ratio which is more towards consumption.

Anyone encouraging savings in the downturn phase is doing a good thing for two reasons. First, the more the savings/consumption ratio, in a non-central bank money manipulation way, stays where it is the more it will be able to save the previously-manipulated structure created during the boom/money printing period of the central bank. Second savings is always good, It provides the money to build the machines that make everything from automobiles to flat screen televisions to iPhones. At some price, consumer products will always clear the market, but what we really need is savings to create more machines that will ultimately create more consumer products. That's what raises the standard of living of a country.

The great Austrian economist, Murray Rothbard, in his book, For A New Liberty, explains the importance of  savings during a recession. You should read it now, starting on page 228 with the section titled Credit and the Business Cycle (but especially pages 238 and 239).


  1. When the central bank prints money it lowers the interest rate, which encourages more consumption, not savings, right? That's why when the new investments mature people don't have any money to buy the products of it (unless they go into debt). So why do you say the savings/consumption ratio leans towards savings during the boom?

  2. It may not lower interest rates. The current period is evidence. The Fed is printing and rates are climbing.

    For the most part it goes to the investment sector, which in my view includes homes and automobiles. Thus the savings consumption ratio goes in favor of savings.

    I don't know what you mean when you say when investments mature, people don't have money.

  3. When I said "investments mature" I was thinking about the Hayek Triangle that illustrates the relationship between capital goods and consumer goods. When the interest rate is artificially suppressed, there's more incentive for borrowing and less for saving...people borrow more for capital projects, but they're not borrowing savings so when the capital goods are used to make consumer goods (what I meant by "investments mature"), there isn't any money to buy the consumer goods.

    I think I was confusing printing money with lowering interest rates. It's lowering interest rates that causes the break in the Hayekian Triangle (not necessarily printing money, I guess). If it's still not clear what I was trying to say, I'm just paraphrasing Roger Garrison's powerpoint on ABCT as best I can.