Grasping Reality on TypePad, by Brad DeLong

Jeebus! Casey Mulligan is at it again!

I can understand getting this so wrong... in 1803. But today, in 2012? Jeebus!

Casey Mulligan:

Casey Mulligan: I agree that unemployment benefits and other safety net benefit payments are many times financed with taxes in the future or taxes in the past. But that “financing channel” still does not make the payments free from the perspective of today’s economy. Suppose the government has been borrowing the money to pay for unemployment benefits. It borrows money by selling bonds. The purchasers of those bonds have less to spend on something else...

Karl Smith continues to take up St. Paul's job of Apostle to the Gentiles--to the Austerian and the Austrians. Today:

No, Brad I Am Not Giving Up Yet, Why Do You Ask?: Lets try it this way. I am going to number each statement so anyone can point out the number where they think we disagree.

1. The Treasury market is fully liquid
2. Anyone who wanted to buy a T-Bill could.
3. Yet, people are not choosing spend all of their funds on T-Bills
4. They are not doing so because at the current interest rate their holdings of T-Bills are optimal
5. If the interest rate on T-Bills does not change private parties buying behavior will not change
6. If the interest rate on T-Bills rises above the interest rate paid on excess reserves then banks will use excess reserves to buy T-Bills
7. Banks will continue to do this until the price of T-Bills falls to the interest rate on excess reserves
8. Once Banks have achieved this the interest on T-Bills will be once again equal to the interest rate on reserves
9. The incentives for non-banks buyers will not have changed
10. Thus all the funds to pay for T-Bills are drawn from excess reserves

Where will the money come from? >It will come from here….To be clear for this example there is nothing special about the excess reserve set up, apart from the way the Fed has always worked. However, it should be abundantly clear where the money comes from now that there is a huge pile of money and not simply the daily creation and destruction of reserves to make the excess equal zero.

And earlier:

Hayek and Macroeconomics: I have been and am still eager to engage Austrians generally and Hayekians in particular in debates over macroeconomic fluctuations. This is not because I believe – as many have suggested – that Real Business Cycle Theory over even the Chicago emphasis on micro-foundations are Hayekian. They don’t seem to be to me. Its because in my mind Hayek’s explanation of the business cycle is a beautiful example of a theory whose only vice is that happens not to be true. Its brilliant. Its elegant. Its parsimonious. It possess boundless fecundity. It’s the kind of thing we expect from brilliant minds. It just happens to be wrong.

And, this is a crucial, crucial, crucial point.

The world is not something that makes sense to us. The world is something that is. Its entirely possible for very beautiful sensible things to just be wrong.

For me, I will say the first instance of this was reading as a child the debate between the Steady State Universe and the Expanding Universe. Obviously, the Steady State Universe is far more beautiful, far more sensible. It lays to rest dozens of meta-physical questions and produces a model of the world in harmony with our spirit as human beings.

It's also wrong.

I remember so badly wanting it to be true and when I grew up wanting to discover that the expansionist had been wrong. That this theory – the theory that deserved to be true – was true.

But, it's not true.

It's not true.

This is painful but its real. And, we have to decide at some point whether we want to bask in the joy intellectually fulfilling views of the world, or whether we wish to see the world as it is, warts and all....

[I]n the early 1980s the US Federal Reserve crushed down on the inflation rate, producing immediate unemployment. This is somewhat anomalous from Hayek’s prescription because the initial phase of distortion doesn’t produce contraction. However, let that be. What really makes the difference is that when the Fed decided to stop, without telling anyone by the way, the economy boomed. Naturally, after such a harsh period of dislocation resources were away from their long run best uses. It should take time to readjust. However, it took no time. In months the economy was accelerating rapidly and what’s more the inflation did not come back.

Perhaps ironically, I don’t know, we can see why if we sit and pick a part business cycle fluctuations on an industry by industry, even job type by job type level. Resources don’t shift around. New modes of production or ways of satisfying consumer demand are not created at an unusual rate. Indeed, the rate of creative destruction actually falls. Fewer jobs are destroyed. Fewer new firms are created. Most importantly, specific types of production go into hibernation – the building of transportation equipment and the construction of structures. Those workers for the most part move very slowly into other industries, if at all.

And, amazingly when the recession is over they go right back to doing what they were doing before. No change at all. Same cranes, same hammers, same assembly lines. Often the same model lines for the cars and the same blueprints for the buildings. It's not a shift, it’s a hibernation.

A shift would be more elegant. It would make sense. It should be true.

It's just not true, in this world.

From my perspective, the most interesting thing about the Hayekian and Austrian claims is how little they trust the market. We build 1.25 million houses instead of 1 million houses for three years because we mistakenly think that the cost of capital and the risk-bearing capacity of the market is higher than it really is. We recognize our mistake. The market then has to shift resources out of construction and into other forms of activity.

It should do so smoothly. Prices of houses fall. Construction workers on piece rates conclude they could make more money retaining for other occupations. The market takes care of it. This is what markets are good at. This is why we like markets rather than command-and-control.

But no, the Austrians say, instead of a smooth shift we need to render 1.5 million construction workers idle, render an additional 6 million workers in other industries idle, and keep them that way for four years.

The striking contrast between the Hayek of the magic of the market and the Hayek of the business cycle is badly in need of explanation.

And I have never seen one provided.