One More Working Paper on Business Cycle Theory

The Mercatus Working Paper series now includes the following, co-authored with Gene Callahan:  "The Role of Ideal Types in Austrian Business Cycle Theory."  An earlier version was presented at the SEA meetings last November, as well as at the Wirth Institute Conference in October.  Gene and I thank a number of commenters at both events as well as referees at Advances in Austrian Economics, where the paper will appear next year, for their suggestions.

Comments

[Lee Kelly]

It's kind of boring to read, but then it *is* and economics paper. In any case, it presented a new and interesting way of thinking about ABC. Thanks!

[Bill Stepp]

This is a good paper with a fine explanation of the causes and conditions of the ABC. It also buries rational expectations, which hopefully won't be resuscitated.
I would caution about the use of the term "Ponzi scheme," as an example of a mania.

You write, p. 10: ""We suggest that particular asset markets sometimes are closely analogous to a Ponzi scheme."

Ponzi schemes may be manias, but they are also based on fraud, unlike, say, a stock market mania.
As far as I can tell, Madoff's Ponzi scheme didn't have any fundamentals backing it. He hadn't done any actual trading in the fund for a few years (which makes me wonder how his son, who ran his legitimate trading operation, couldn't have known something was amiss). He was using proceeds of later investors to cash out some earlier ones, as well as to pay for his homes, yachts, etc. The "gains" reported to his "investors" were apparently nonexistent.

I disagree with Schiller's use of the term "Ponzi scheme" in describing investment manias, as least insofar as the markets he refers to are not riddled with fraud (a few companies like Enron, Tower Financial, etc. don't make the whole market fraudulent).
I marked several pages of his "Irrational Exuberance" book with comments about this.

There might be some actual Ponzi schemes with real fundamentals that are overvalued by naive investors, but I have to admit I don't know of any. (The term investor suggests studying the underlying fundamentals of an investment, i.e., financial statements. What fundamentals do "investors" in Ponzi schemes study? I suppose Madoff's clients studied his phoney annual statements.)

Concerning Big Players, actors who influence markets but are immune from profit and loss signals, you write (p. 14) that "[i]t is also possible to envision, for instance, the mananger of a very large investment fund fulfilling the type." How is a large fund manager insulated from profit and loss? Some very large fund managers recently had large withdrawals due to big losses. I don't understand how any fund manager, large or small, is immune from the discipline of the market. A fund manager has to be attentive to the profitability (or lack thereof) of what he invests its assets in, as well as the possibility of clients withdrawing their funds, and what that might mean to the profitability (or lack thereof) of his fund's operations.
I was also amused by the reference to Krugman's 1998 essay, which I thought said more about him than about the ABC.