LibertyHQ forums

I feel that Rothbard's reasoning here is a little sloppy:



The problem is that he is looking at deflation in a specific industry. He doesn't address deflation in the overall economy.

In the exact same line of thought, it's not a bad thing that the horse and buggy declined. But it's certainly a bad thing if the entire economy suddenly were to disappear.

Is Rothbard being sloppy?

I guess he's referring to a specific example for readers to relate to. Deflation through growth and increased productivity is a good thing and he attempts to demonstrate this by using an industry specific example. Falling prices in the computer industry didn't lead to drop in profits because of sticky wages or consumers deferring purchases perpetually in anticipation of those falling prices. Joseph Salerno uses the same example in his book "Money, Sound and Unsound" :



His section on growth deflation is on page 272 - http://library.mises.org/books/Joseph%2 ... nsound.pdf

We can see he assumes a constant money supply, since he writes about no central banks or govt meddling. He also assumes that there is no hoarding, since in reality there never is. OK, given that, prices are determined solely by supply and demand. Since no money is hoarded, AD can't be less for that reason. So what is causing price deflation? Must be increased production, the case he was discussing for a single industry. IOW, the overall economy works the same way as the single industry.

I'm not sure what you mean by an entire economy suddenly disappearing. Do you mean a meteor strikes all the farms and factories? I don't think that case need be discussed, but sure it would be bad. The idea is that anything that increases net production of consumer wants is good, even it means one particular industry has to go down because of it. If an entire economy disappears, that means production has gone down overall. Not analogous to the case of horse and buggy, where the rise of one industry causes the fall of the other.

You're certainly on the right track that Rothbard's being a little disingenuous there because the very process of how deflation in the economy at large would work is completely different than how it functions in industries which are experiencing industrial innovation. The causal factor is not a consistent fall in consumer demand, but rather an increase in the ease with which certain goods can be produced.
I think that a free market would probably function permanently below capacity (even more so than is inherent within the system) because of constant deflation. This is almost certainly better than the constant threat of a business cycle, however.

Could you elaborate on this? How does deflation work in industries and how does it work in the economy at large?



Which deflation is because of consistent fall in consumer demand, and which one because of an increase in the ease etc?

Are you saying that deflation in an economy as a whole is caused by a consistent fall in consumer demand?

What is your source for such a claim? In addition, Is it an Austrian concept, one that is not of Austrian origin but accepted by Austrians, or one that is totally foreign to AE?

What makes consumer demand fall consistently? Demand has two components. Desire to buy and ability to pay for it. If you mean a consistent fall in the desire to buy everything in the whole economy, I guess that means everyone has decided to become buddhist monks, living in the streets and eating out of a begging bowl. Yes, that is different from what happens in a single industry, but also differen from what happens in the real, as opposed to Bizzaeo, world.

If you mean consistent fall in ability to buy, how can this happen? What happened to all the money that existed yesterday? Did a fire burn up all the computers in which 90% of our money exists? And I guess this happens every day for years, because we are talking about something consistent. Every day billions of dollars just are wiped off the face of the Earth, somehow or other. And Rothbard was disingenuous not to talk about this. I dunno.

[/quote]I think that a free market would probably function permanently below capacity (even more so than is inherent within the system) because of constant deflation. This is almost certainly better than the constant threat of a business cycle, however.[/quote]

Is this just a wild guess of yours with no evidence or reasoning behind it, or do you have some support for it? Please tell us what it is, if it exists.

That's exactly what he's not saying.

To articulate my original concern a little better:

When there is a general fall in the price level, that means that investment becomes less attractive across all industries. If the fall in price level is just in one industry, the resource can be reallocated to other ones.

I was almost entirely incorrect in my assertion above because I was confusing what caused deflation in the first place. While it is possible to envision a world in which demand to hold money is continually decreasing, there is no reason to necessarily believe that this would be the case. While this does and has happened, the irony is that in the absence of the government attempting to increase the money supply to stabilize purchasing power eventually causes the very crises that lead to an increase in the desire to hoard money. Whenever this does occur and individuals desire to hold more money, the causal factors of deflation are different than increases in the output of goods and services.
Deflation in the strict sense of an increase in the purchasing power of the monetary unit is caused by an increase in the demand for money, a decrease in the supply of money. Here I am assuming a fixed money supply and therefore the only thing which affects the value of money is its demand. The demand for money fluctuates partially because of what is exchangeable for it and alterations based upon things like future expectations and changes in the population. If the population continually increases then the value of money will continually rise. If the quantity of desired goods in the economy continues to rise then the value of goods relative to money also decreases and the value of money increases.
Therefore increases in the quantities of goods and services in the economy can only be caused by changes in the quantities of the factors of production or in the efficiency which they are used to produce output (technological improvement). This will increase the value of money. The value of money can also be increased by other means which I have mentioned above. If all demand curves in the economy were somehow fixed, then the supply curves would slowly ever rightward and provide ever more goods and services at ever lower prices. This is what Rothbard is observing in the computer industry except on a scale so exaggerated that it can actually see through consistent inflation.

While Dave was slightly confused upon what my point was, I can't blame him exactly because my point was confusing.



This was much more along the lines of what I was thinking, however, you have to remember that what's happening here is that due to an increase in the quantity of productive factors the prices of these factors relative to money fall. Entrepreneurs will presumably be able to approximately determine the alteration of this rate as a response to what they are doing. Therefore they can adjust how much they are willing to invest accordingly. If the price of captal good X will fall then they will not invest as much as they otherwise would. So long as they believe the return to their investment to be positive then they will invest.

The error I was falling into was in conflating a decrease in the money supply or in the desire to hold money with an increase in the value of money which comes from the goods side. This is fundamentally different because entrepreneurs see a change in the prices of their commodities which comes from them, from their own bidding down of the prices of the productive factors or through a technological increase in the efficiency of what they produce. This means that they can plan and act accordingly on each level, rather than having to wait until the prices of goods on every level of the production structure have fallen in order to allow for the profitable production of goods which will lead to consumers goods.

Does that make sense?

Here's what I think you mean. Rothbard was talking about computers. The sequence of events he describes is as follow. A cheaper way has been found both to make the computers themselves as well as supplying the resources needed to make them. Those two reasons increase the supply of computers as well as decrease the price of a computer. The computer thus becomes affordable to more people. Whatever loss of profit per unit sold is more than compensated for by increased sales.

You are describing a different situation, where the loss of profit per unit has driven people out of the business of making computers. But at least they can make dog food instead, or whatever. But if prices of everything falls, making it unprofitable to make anything at all, then there is no escape. There is no way to make a buck anymore, so everything shuts down.

That's my understanding of your question. What I've seen about this question, filtered through my understanding of it, is as follows:

First, let's make sure we are describing the same situation. There is no decrease in the money supply, because that's the case Rothbard is talking about. Since you are saying Rothbard's argument won't work across a whole economy, I assume you mean that the same situation Rothbard described has happened across all industries. So that prices have gone down across the board due to increased production across the board.

Note that the purchasing power of the population has not dropped, but rather increased. Since purchasing power comes from what one produces [Say's Law], and production is up for all, so is purchasing power. And indeed that is reflected in lower prices. The same dollar buys more. So that mankind looked at as consumers have gained, not lost.

But what if we look at mankind in the role of producers? Since prices have gone down for everything, then profits must have gone down, too, right? Well, no. There are two reasons. First, because if prices of a product have gone down, that will force prices of the factors of production to go down. If someone is making gold watches, and has to sell them cheaper, he will turn around to the gold mines and say he cannot afford to pay as much for gold. Who will they sell their gold to? Everyone is in the same boat. No one else can afford to pay the same high price for gold, either. Thus the mines will have no choice but to drop the price of gold. Thus, the profits for the watchmaker are still there.

But what of the gold mines? Have they not lost? Nominally [= in name only], yes. They used to get $1,600 an ounce, now they have to settle for $1,500. But as we stated earlier, the $1,500 is worth more than it used to be worth. Indeed, it will buy as much, if not more, than the $1,600 used to. [I'm a bit shaky here. Is this a certainty, or a possibility, or something that following the assumptions about the numbers will show must be true? Not clear to me].

Bottom line, increased production for all means increased wealth for all, though it may not show up in the numbers, but rather in purchasing power.

My source for all this is primarily Rothbard's History of Economic Thought, in the chapter on J. B. Say.

The differentiation should be between supply-driven and demand-driven deflation. In the opening post, Rothbard is talking about the former, also known as secular deflation. Note that despite a fall in the price per unit of output this doesn't necessarily imply a fall in either nominal or real income. A simple illustration: suppose an economy with one industry that produces one good. The money supply is $100 and money only exchanges against this one good. Let's say that at time t the firm produces 10 units, at a price of $10 each: $10 x 10 = $100. At t+1 production grows to 20 units and prices halve: note that even in this case income remains $5 x 20 = $100. It should also be kept in mind that the prices of inputs (capital goods) are imputed from the expected prices of outputs, meaning that a fall in output prices will also lead to a fall in input prices. This is why I disagree with Keynes' contention that the marginal efficiency of capital will decrease as capital accumulates (and why I disagree with the notion that falling prices due will necessarily decrease income accruing to investors). (This is not to say that there may not be "negative" consequences even to secular deflation: there is a literature on the theory that positive productivity shocks can lead to higher unemployment — I'm not sure I agree with it, though.)

The question of demand-induced deflation is separate. Austrians might see this as a product of bigger problems — e.g. a secondary consequence of malinvestment —, but those that follow a strict Rothbardian line still oppose maintaining monetary equilibrium by increasing the money supply (rather than simply through an adjustment of prices). I've hopped back-and-forth across the fence, but lately I've become much more sympathetic to the old monetarism of monetary disequilibrium. The way to think about this phenomenon is as follows. Suppose the money supply is $100 at time t, which equals money demand during the same period. However, at time t+1 the demand for money rises to $150. This means that those that hold the $100 at that time will increase their cash balances, reducing the number of transactions and therefore disallowing others to increase their own cash balances. Unless prices adjust (inducing a fall in desired nominal cash balances), there is a shortage of $50 ($150 - $100). This implies a reduction in aggregate exchanges; i.e. a reduction in trade (and output). Personally, I've come to believe that there are nominal downward rigidities even in a completely free economy (one example is efficiency wage theory as applied to the business cycle), and that in such a free economy alternative means of preventing reductions in trade activity come into being: one example is free banking, where an increase in the demand for money allows for an increase in outstanding private liabilities in the shape of private banknotes.

http://mises.org/daily/1254

Hulsmann kills all fear of deflation in this article. I don't think you need to read anything else.

By the way, how do I create a hyperlink on this forum. I see the URL button, but not sure how to use.

I don't understand something about this. It seems like an increased demand for money would really just mean an increased demand for one or several goods on the market, meaning I want the money so I can go buy some other good with it that i cannot simply barter for. Is a spike in demand for money like this only existent if we are assuming a free market?

It seems like that is the only case where spikes in demand for money really occur, being that money is a good in and of itself. I know that outside of a free market, it still acts like a good also, given that increased supply tends to decrease demand. But with fiat currency, money (if you can really call it that) is only useful in so far as it buys other things, and may make one feel more secure.

But, maybe I am applying rational (not in the praxeological sense) thought to everyone as if people think that way. I guess it is no different than a diamond. Fundamentally useless, yet contains perceived value due to its rarity and cultural significance.

I guess my question realles comes down to the following: Wouldn't an increase in demand for money simply represent an increased demand for some other good, or is it that you demand the money first, then once acquired, you demand the good it buys you?

Thanks.

Diamonds have other important uses, but yeah their beauty is the main source of their prestige (...and the de Beers government-aided cartel trying to limit their supply.)

From:

forum-guidelines-and-useful-tips-t4.html

There can be various reasons motivating a rise in cash balances. But, when you reduce cash balances the only way you can do that is by selling money, which is the same as buying goods. To increase cash balances you have to sell goods, that is buy money. But, it also means that as long as your preferred cash balance is at a certain level, you won't sell money beyond it (I mean, you won't reduce your cash balances until you want to). So, it represents a decreased demand for other goods and an increased demand for money.

True, it's a micro example, but need a theory be applied with macroeconomics as its goal to be considered valid?