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New Evidence Supporting an Austrian Business Cycle Interpretation of 1995-2012


The Wall Street Journal, in a front page article, Household Income Sinks to '95 Level ,   summarizing a Census Bureau report released Wednesday, reports, “The income of the typical U.S. family has fallen to levels last seen in 1995, a long and pernicious slide that likely means it will be a generation before Americans regain the peak income levels reached at the close of the '90s”.  While one should always be careful using median income figures, the data is consistent with and can be best understood when combined with a capital-structure macro model of the economy. A caveat, given that the  peak of the 90s was at the close of the first artificial boom, it most likely overstates sustainable income based on ‘real’ capital available.

A first thing to notice is the timing of the apparent rise and decline in median household income  beginning in the mid 1990s.

Recent analysis (Garrison, Interest-Rate Targeting During the Great Moderation, and Natural Rates of Interest and Sustainable Growth; and Cochran,  Hayek and the 21st Century Boom-Bust and Recession-Recovery) using an Austrian, capital-structure based macro-economic model argues the U. S. suffered back to back boom bust cycles, the dot.com bust and the more recent and more devastating boom-bust accompanied by the housing bubble. These economy-wide boom-busts coincide with the two booms and busts in household income during the same period.

Frank Shostak, author of today’s excellent analysis of the Fiscal Clift (http://mises.org/daily/6185/Is-the-Fiscal-Cliff-a-Threat-to-the-Economy), has long argued that a key, but often overlooked feature of a policy driven boom-bust is capital consumption and hence wealth destruction. Two recent articles in the QJAE strongly reinforce this point; Ravier’s  Rethinking Capital-Based Macroeconomics and Salerno’s A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis.

Ravier (369) argues:

On the other hand, and this is the most relevant aspect, due to the mal-investment process during the stimulus phase we also face a situation in which the potential productive capacity of the economy and thus the real wages potentially earned once the economy returns to normal levels of employment is reduced as a consequence of the partial destruction of capital [Bold emphasis mine]. Many authors, including for example Huerta de Soto (1998, pp. 413-415), focus attention on the “partial destruction of capital” that inevitably occurs because there is a category of resources which are lost when investment projects are abandoned. Stimulus significantly increases the volume of resources that ultimately fall in the “sunk cost” category: at the end of the stimulus phase, some resources have already been committed to investment projects but are not yet productive; when the stimulus phase ends and it turns out that these projects are not going to be completed, these resources are “sunk” costs and not re-assignable to new projects.

Salerno (29-36) provides several pages of discussion relative to the wealth destruction which followed the most recent bust and non-recovery. Figures 9-11 and 14 are most relevant. A summary (36):

After reaching a high of $15.5 trillion in 2007, the index collapsed and fell to a low of $8 trillion in early 2009. As I write this, the Wilshire 5000 has been fluctuating around $12 trillion, a level it first reached in 1999. This implies that there has been no net capital accumulation in the U.S. economy since 1999. The capital that has been accumulated since then has either been consumed or wasted in misdirected investments. But it may happen that even the current level of wealth and income is based on false calculations, because the Fed has used every tool at its disposal and has even forged new ones in order to prop up housing and financial asset prices. The weak and tenuous recovery that the U.S. is now experiencing may well be a reflection of the depth of capital consumption and impoverishment that the U.S. economy has suffered as a result of the inflation-targeting policy of the past two decades [emphasis mine].

This new data just reinforces Salerno’s argument.

Monetary policy and government is, not only per Hayek ( 1979, Unemployment and Monetary Policy: Government as Generator of    the “Business Cycle”. San Francisco, CA: Cato Institute.), the “generator of the “Business Cycle, but boom-bust cycles have lasting impacts on households well beyond the recession itself. Another strong piece of evidence that monetary reform – denationalization of money is imperative for a vibrant economy based on sustainable growth.  

John P. Cochran (1949-2015) was emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He was also a senior fellow of the Mises Institute and served on the editorial board of the Quarterly Journal of Austrian Economics.

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