[kbxcoop]

I have a question regarding fiat money vs. a gold standard in times of the bust during business cycles. In business cycles prior to 1971, did the monetary supply contract? Why did it do this? And then, with fiat money, can the money supply contract during a bust?

Another question is about exchanges. I was reading “Praxeology of Coercion: Catallactics vs. Cratics”. The paper starting to talk about “offer”. So, when we talk about action, would it therefore make sense that, for an exchange to occur, that there must always be someone who starts that exchange by offering (whether a trade or a threat of force)?

[jmherbener]

Prior to 1940, the money stock typically contracted significantly during a bust. People move toward holding currency by cashing out their checking account balances (or, in the 19th century, redeeming bank notes). The money stock shrinks as the bank money substitutes are eliminated.

After the Second World War, the money stock typically does not contract significantly during a bust. The Fed has manged to re-inflate during the bust by expanding its purchase of securities from banks. Even with fiat money, however, it is possible for the money stock to decline during the bust. It depends on the counter-veiling causal factors at work: the Fed’s attempt to re-inflate by expanding bank reserves versus people building cash reserves.

In my reading of the article, the author (p. 305f) is not suggesting what you’re implying. He is merely saying that when a catallactic offer is made it conveys only a promise and likewise with cratic offers.

https://mises.org/system/tdf/Praxeology%20of%20Coercion%20Catallactics%20vs%20Cratics.pdf?file=1&type=document

[kbxcoop]

I was recently learning about the IS-LM Curve, and when I read about how increased Real GDP (Y) increases the demand for money in the economy, and therefore increases the rate of interest, I became curious if the demand for money actually did increase the pure rate of interest. Reading through Man Economy and State, I noticed Rothbard said that it did not affect the pure rate of interest. I then read an article on Mises.org (The demand for money and the time structure of production), and the conclusion was that the increased demand of money increased the pure rate of interest. So I have a few questions:

1) When it comes to the Keynesian LM relationship, is this relationship, and the reasoning, plausible?
2) Looking at time preference, and looking at the ratio between present and future goods, Murray says that when people add to their cash balances, the left over income still has the same proportion as before (ex. 100 oz income, with 20% saved means 80 Is consumed, 20 is saved, and if cash balances was increased by 20, 64 is consumed and 16 saved). The author of the article states that the pure rate of interest increases due to the fact that, since money is now more valuable in relation to the costs to produce it, that more capital and labor is pulled from other investment projects and put into money production (assuming commodity). So a couple of questions:
1) Aren’t cash balances present goods? If they were, wouldn’t it make sense that cash balances are only pulled from consumption, so that the pure rate of interest and rate of investment is the same in society?
2) Who is right here? Are they both wrong in their conclusions?

[jmherbener]

The IS-LM model stipulates certain “channels” of influence that one variable has on another. These stipulations are Keynesian and therefore subject to critique from an Austrian viewpoint.

Keynes asserted that the interest rate is determined by the stock of money and the demand to hold money. This effect occurs indirectly as people trade money holdings for bonds in their asset portfolios. People sell bonds to satisfy their demand to hold more money and therefore, interest rates rise as the necessary consequence of bond prices falling.

Austrians counter that as a medium of exchange people hold money in lieu of demand for goods in general and not just bonds. People sell across all goods to satisfy their increased demand to hold money and therefore, prices in general fall.

Furthermore, unless time preferences change during the transition between the original and higher demand for money, the ratio between consumption and saving-investing will not change. Time preferences determine both the pure rate of interest and the ratio of consumption to saving-investing. It doesn’t seem to me that the unnamed author provides an argument to show that time preferences necessarily change in the transition. He has simply stated, correctly, that the composition of investment will shift away from other goods and into commodity money. But commodity money production is no different than the production of any other good in the economy in terms of generating a rate of return. And so, his case is no different than increased demand for smartphones leading to an increase production by pulling capital and labor out of the production of landline phones. Such changes in the composition of investment do not affect the rate of return or the proportion of resources in the economy devoted to saving-investing, both of which are determined by time preferences.

[kbxcoop]

I’m sorry, I forgot to link the article.
https://mises.org/library/demand-money-and-time-structure-production

The article states that, atleast what I got from it, is that, when the demand for money rises, the price of all inputs in the economy fall. When demand shifts from land lines to cell phones, the input prices of the land lines falls relative to the increase of prices of the inputs to cell phones, because the price of outputs change relatively the same. When money demand increases, however, the input and output prices of everything else falls, and the input prices for money falls, so resources must necessarily flow into money creation. Therefore, that spread between input and output of everything else in the economy must widen in order to “shrink” or reduce the spread of the inputs and outputs to money creation. Correct me if I am wrong please.

[jmherbener]

Well, that’s what the author claims. But I don’t see why it must be so. Time preference determines the price spread between output and input prices. The demand for and supply of money determine the PPM overall. The two are not related in any logically necessary fashion. The author assumes that when the rate of return in money production is increasing from increasing money demand that the rate of return in other lines has stayed the same. In fact, the rate of return must be falling in lines of production in which demand has gone down to allow the increase demand for money. People satisfy their increased demand for money by reducing their demand for, and increasing their supply of, other goods.

In other words, the rising rate of return in money production is balanced by a falling rate of return in other lines so that when the reallocation of resources is finished, the rate of return is the same as it was before money demand increased and demand for other goods declined. As long as time preferences don’t change during the process, the rate of return overall will not change. The only difference between this case and the case of demand shifts between goods other than money, like landline and cell phones, is that in this case the PPM also changes during the adjustment process.

[kbxcoop]

So would it make sense to say that cash balances are present good, and that, if time preference doesn’t change, that additions to cash balances can only come from a decrease in consumption?

[jmherbener]

An addition to money holdings is not consumption. It is plain saving, which as you suggest, is a present good, but not a consumer good.

If a person’s time preference doesn’t change, then his ratio of Saving-Investing to Consumption does not change. With his time preference constant, for a person to fund an addition to his money holdings out of his given income on anything, he must draw the funds out of consumption and saving-investing in the same proportion. If he draws the funds exclusively from consumption, then the ratio of S-I to C would necessarily change.

[kbxcoop]

I’m confused on this point. If time preference is the ratio of present to future goods, and cash holdings are a present good, wouldn’t the only way to keep that ratio the same is for cash holdings to only come at a decrease of consumption. Am I confusing the nature of cash balances and savings? Is it because cash balances are used for future purchases?

[jmherbener]

Here are the categories of Goods:

1. Present Goods
a. Consumer Goods
b. Media of Exchange
2. Future Goods
a. Producer Goods

Income = Consumption + Saving-Investing

Here are the categories of Saving-Investing:

1. Plain Saving-Investing: Storing existing goods.
2. Capitalist Saving-Investing: Diverting resources from more direct to more indirect production.

Time preference determines the ratio of consumption to capitalist saving-investing and the interest rate of return on production. Capitalist saving-investing earns a rate of interest.

People hold money balances to deal with the uncertainty of the future. Money holdings are plain saving-investing. Plain saving-investing does not earn a rate of interest.

In the ERE there would be no money holdings at all, yet there would be capitalist saving-investing and a capital structure of production for producing consumer goods. Also, all production would earn the interest rate of return, but there would be no profits or losses.

[kbxcoop]

I think I am missing something that just isn’t clicking.

Let’s assume this. If I have 100 ounces of gold, and my time preference ratio is 10%, and I have no demand to gold money, my allocation would be 90 consumption 10 saving- investment. If I were to demand more money, say 10 ounces, my allocation would then be 10 ounces to gold, 81 consumption, and 9 investment. What I dont understand is that how can the interest rate stay the same (10%) when the demand of overall present goods went up. So now, there is only demand of 9 ounces for future goods, and 91 ounces for present goods. So I think the problem I am having is seeing the difference between if someone were to a) consume 91 and save 9, and b) someone holding 10 ounces, consuming 81, and saving 9. Between these two scenarios, to me it doesn’t make any sense how the interest rate between a and b can be the same. Am I completely over thinking this?

[kbxcoop]

After a little bit of thinking of the example above, it finally clicked. When people demand to hold more money, the PPM goes up, therefore people can buy more consumer/producer goods. Since consumption went down (90-81) more than investment (10-9), prices of consumption goods fall relative to the rise of value of money, therefore the price spreads between present and future goods would be the interest rate.

[jmherbener]

The key point, as you note, is that an increase demand for money raises the PPM, that is prices fall from the concomitant decrease in demand for goods, both consumer and producer goods. If time preferences stay the same, then the price spreads between consumer and producer goods must stay the same, i.e., the rate of return in production must stay the same. The extent to which the PPM rises, then, will depend upon maintaining the same price spread between the now lower prices of both consumer goods and producer goods. To put the point more generally, prices are flexible enough to adjust throughout the economy to maintain both a unchanging interest rate of return on production and a lower overall price structure in the face of an increase in money demand.

[kbxcoop]

During the boom part of the boom bust cycle, we understand that profits due To monetary inflation causes capital consumption. During the boom part, some prices are going up faster than others. For example, prices of houses went up faster than the price of cars. In this scenario, since resources are being drawn to the housing market, and less resources are being drawn to the car industry, would there be more capital consumption in the housing market or car market?

[jmherbener]

Capital consumption is manifest during the liquidation and reallocation of the bust. One could examine the extent of capital consumption empirically by looking at the bankruptcies, stock collapses, etc. Because the boom is a period of over-consumption and mal-investment, the greatest lines of mal-investment are in particular consumer goods, e.g., houses, and cars, and the higher-stages of production, e.g., commodities. The degree of mal-investment in any particular line depends on how the boom-level capital capacity lines up with the recovery-level capital capacity. You cannot determine that by comparing mal-investment in one line during the boom with mal-investment in another line during the boom.

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