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The Ricardo Effect

Cowboy0108
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5/13/2015 10:30:49 PM
Posted: 1 year ago
What is your opinion of the Ricardo Effect. Hayek used it as evidence to contradict classical Keynesian spending policy.
The Ricardo effect, as I interpret it, basically says that when the government engages in deficit spending to combat recession, its citizens pay for it during prosperity with tax hikes and lack of confidence in the economy. Thus, the economy does not reach its full potential during prosperity.
I agree with this, but I know that it is obscure economic theory and could be disagreed with, so what do you think?
lannan13
Posts: 23,074
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5/15/2015 2:28:51 PM
Posted: 1 year ago
At 5/13/2015 10:30:49 PM, Cowboy0108 wrote:
What is your opinion of the Ricardo Effect. Hayek used it as evidence to contradict classical Keynesian spending policy.
The Ricardo effect, as I interpret it, basically says that when the government engages in deficit spending to combat recession, its citizens pay for it during prosperity with tax hikes and lack of confidence in the economy. Thus, the economy does not reach its full potential during prosperity.
I agree with this, but I know that it is obscure economic theory and could be disagreed with, so what do you think?

Keynesian economics are just God aweful and highly inaccurate.
-~-~-~-~-~-~-~-Lannan13'S SIGNATURE-~-~-~-~-~-~-~-

If the sky's the limit then why do we have footprints on the Moon? I'm shooting my aspirations for the stars.

"If you are going through hell, keep going." "Sir Winston Churchill

"No one can make you feel inferior without your consent." "Eleanor Roosevelt

Topics I want to debate. (http://tinyurl.com...)
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Cowboy0108
Posts: 420
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5/15/2015 2:32:42 PM
Posted: 1 year ago
At 5/15/2015 2:28:51 PM, lannan13 wrote:
At 5/13/2015 10:30:49 PM, Cowboy0108 wrote:
What is your opinion of the Ricardo Effect. Hayek used it as evidence to contradict classical Keynesian spending policy.
The Ricardo effect, as I interpret it, basically says that when the government engages in deficit spending to combat recession, its citizens pay for it during prosperity with tax hikes and lack of confidence in the economy. Thus, the economy does not reach its full potential during prosperity.
I agree with this, but I know that it is obscure economic theory and could be disagreed with, so what do you think?

Keynesian economics are just God aweful and highly inaccurate.

Agreed. The only thing about keynesian economics that I agree with is its stance on deflation. It says that deflation leads to the expectation of deflation. This encourages people to wait to spend their money until the prices drop more. Thus, the demand decreases. Still, this only applies to some items, mostly big ticket items or items that devalue slowly, like cars and houses. Movie tickets and gas will actually see an increase in demand which is what Austrian economics says about deflation.
lannan13
Posts: 23,074
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5/15/2015 3:03:34 PM
Posted: 1 year ago
At 5/15/2015 2:32:42 PM, Cowboy0108 wrote:
At 5/15/2015 2:28:51 PM, lannan13 wrote:
At 5/13/2015 10:30:49 PM, Cowboy0108 wrote:
What is your opinion of the Ricardo Effect. Hayek used it as evidence to contradict classical Keynesian spending policy.
The Ricardo effect, as I interpret it, basically says that when the government engages in deficit spending to combat recession, its citizens pay for it during prosperity with tax hikes and lack of confidence in the economy. Thus, the economy does not reach its full potential during prosperity.
I agree with this, but I know that it is obscure economic theory and could be disagreed with, so what do you think?

Keynesian economics are just God aweful and highly inaccurate.

Agreed. The only thing about keynesian economics that I agree with is its stance on deflation. It says that deflation leads to the expectation of deflation. This encourages people to wait to spend their money until the prices drop more. Thus, the demand decreases. Still, this only applies to some items, mostly big ticket items or items that devalue slowly, like cars and houses. Movie tickets and gas will actually see an increase in demand which is what Austrian economics says about deflation.

I prefer the works of Milton Friedman.
-~-~-~-~-~-~-~-Lannan13'S SIGNATURE-~-~-~-~-~-~-~-

If the sky's the limit then why do we have footprints on the Moon? I'm shooting my aspirations for the stars.

"If you are going through hell, keep going." "Sir Winston Churchill

"No one can make you feel inferior without your consent." "Eleanor Roosevelt

Topics I want to debate. (http://tinyurl.com...)
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Cowboy0108
Posts: 420
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5/15/2015 3:14:25 PM
Posted: 1 year ago
At 5/15/2015 3:03:34 PM, lannan13 wrote:
At 5/15/2015 2:32:42 PM, Cowboy0108 wrote:
At 5/15/2015 2:28:51 PM, lannan13 wrote:
At 5/13/2015 10:30:49 PM, Cowboy0108 wrote:
What is your opinion of the Ricardo Effect. Hayek used it as evidence to contradict classical Keynesian spending policy.
The Ricardo effect, as I interpret it, basically says that when the government engages in deficit spending to combat recession, its citizens pay for it during prosperity with tax hikes and lack of confidence in the economy. Thus, the economy does not reach its full potential during prosperity.
I agree with this, but I know that it is obscure economic theory and could be disagreed with, so what do you think?

Keynesian economics are just God aweful and highly inaccurate.

Agreed. The only thing about keynesian economics that I agree with is its stance on deflation. It says that deflation leads to the expectation of deflation. This encourages people to wait to spend their money until the prices drop more. Thus, the demand decreases. Still, this only applies to some items, mostly big ticket items or items that devalue slowly, like cars and houses. Movie tickets and gas will actually see an increase in demand which is what Austrian economics says about deflation.

I prefer the works of Milton Friedman.

Same. He is my favorite economist. He makes everything so simple and easy to understand, possibly because he spoke with modern diction. The only problem is that I cannot get any of his books as PDFs online for free!
lannan13
Posts: 23,074
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5/15/2015 3:16:27 PM
Posted: 1 year ago
At 5/15/2015 3:14:25 PM, Cowboy0108 wrote:
At 5/15/2015 3:03:34 PM, lannan13 wrote:
At 5/15/2015 2:32:42 PM, Cowboy0108 wrote:
At 5/15/2015 2:28:51 PM, lannan13 wrote:
At 5/13/2015 10:30:49 PM, Cowboy0108 wrote:
What is your opinion of the Ricardo Effect. Hayek used it as evidence to contradict classical Keynesian spending policy.
The Ricardo effect, as I interpret it, basically says that when the government engages in deficit spending to combat recession, its citizens pay for it during prosperity with tax hikes and lack of confidence in the economy. Thus, the economy does not reach its full potential during prosperity.
I agree with this, but I know that it is obscure economic theory and could be disagreed with, so what do you think?

Keynesian economics are just God aweful and highly inaccurate.

Agreed. The only thing about keynesian economics that I agree with is its stance on deflation. It says that deflation leads to the expectation of deflation. This encourages people to wait to spend their money until the prices drop more. Thus, the demand decreases. Still, this only applies to some items, mostly big ticket items or items that devalue slowly, like cars and houses. Movie tickets and gas will actually see an increase in demand which is what Austrian economics says about deflation.

I prefer the works of Milton Friedman.

Same. He is my favorite economist. He makes everything so simple and easy to understand, possibly because he spoke with modern diction. The only problem is that I cannot get any of his books as PDFs online for free!

Free to Choose http://www.il-rs.org.br...
-~-~-~-~-~-~-~-Lannan13'S SIGNATURE-~-~-~-~-~-~-~-

If the sky's the limit then why do we have footprints on the Moon? I'm shooting my aspirations for the stars.

"If you are going through hell, keep going." "Sir Winston Churchill

"No one can make you feel inferior without your consent." "Eleanor Roosevelt

Topics I want to debate. (http://tinyurl.com...)
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lannan13
Posts: 23,074
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5/15/2015 3:26:37 PM
Posted: 1 year ago
At 5/15/2015 3:18:41 PM, Cowboy0108 wrote:
Free to Choose http://www.il-rs.org.br...

THANKS!

Welcome.
-~-~-~-~-~-~-~-Lannan13'S SIGNATURE-~-~-~-~-~-~-~-

If the sky's the limit then why do we have footprints on the Moon? I'm shooting my aspirations for the stars.

"If you are going through hell, keep going." "Sir Winston Churchill

"No one can make you feel inferior without your consent." "Eleanor Roosevelt

Topics I want to debate. (http://tinyurl.com...)
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ResponsiblyIrresponsible
Posts: 12,398
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5/15/2015 5:52:20 PM
Posted: 1 year ago
At 5/15/2015 2:28:51 PM, lannan13 wrote:
Keynesian economics are just God aweful and highly inaccurate.

But it isn't.

I should qualify that by noting that a lot of what Keynes said was in fact batsh1t crazy: the liquidity trap, his "inflationista" tendencies in the 30s, his skepticism toward trade, his support of fiscal stimulus, etc.

But the crux of Keynes was that aggregate demand - total income, total production, total spending, what have you - is important, and explains short-run output fluctuations better than virtually anything else because wages and prices are sticky in the short run and thus markets can't quickly self-correct to their long-run equilibrium - mind you, that's a view that even Milton Friedman endorsed. In fact, he blamed the Fed for the Depression because it didn't do *enough.* In fact, it contracted the money supply appreciably between 1929 and 1932 to lean on a stock market bubble - depending on who you view it, either a financial crisis caused the shortfall in NGDP, or the shortfall in NGDP caused the financial crisis (I tend toward the latter), but the shortfall in overall nominal spending is why the 1930s, as well as the late six years, were so bad.

Frankly, Friedman even partially recanted his rule-based view of a steady M2 growth target in the 90s as velocity trended upwards. Today, he'd likely support an NGDP target - that's interesting, because John Maynard Keynes told us that we should look primarily at indicators such as NGDP and employment. Another person said something very similar: his name was Ben Bernanke - and trust me when I say that he's far from the classic Keynesian sweetheart.

tl;dr: You can't simply disband Keynes. Literally the current theory of the business cycle - almost everything we know about the short run, which is pretty much where we are and have been, save for maybe the Great Moderation (which was probably a fluke, to be honest), is predicated on Keynes.

That said, Friedman is right on fiscal policy, regulation, the role of the federal government, etc., though a monetary policy rule would be disastrous. I'm not even sole on an NGDP futures market as the guidepost for policy.
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ResponsiblyIrresponsible
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5/15/2015 5:55:44 PM
Posted: 1 year ago
As for Ricardian Equivalence, I don't quite buy it - I think crowding out (when we're not at the zero rate lower bound) is a far better explanation of the impact of budget deficits.
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Cowboy0108
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5/15/2015 5:59:05 PM
Posted: 1 year ago
At 5/15/2015 5:52:20 PM, ResponsiblyIrresponsible wrote:
At 5/15/2015 2:28:51 PM, lannan13 wrote:
Keynesian economics are just God aweful and highly inaccurate.

But it isn't.

I should qualify that by noting that a lot of what Keynes said was in fact batsh1t crazy: the liquidity trap, his "inflationista" tendencies in the 30s, his skepticism toward trade, his support of fiscal stimulus, etc.

But the crux of Keynes was that aggregate demand - total income, total production, total spending, what have you - is important, and explains short-run output fluctuations better than virtually anything else because wages and prices are sticky in the short run and thus markets can't quickly self-correct to their long-run equilibrium - mind you, that's a view that even Milton Friedman endorsed. In fact, he blamed the Fed for the Depression because it didn't do *enough.* In fact, it contracted the money supply appreciably between 1929 and 1932 to lean on a stock market bubble - depending on who you view it, either a financial crisis caused the shortfall in NGDP, or the shortfall in NGDP caused the financial crisis (I tend toward the latter), but the shortfall in overall nominal spending is why the 1930s, as well as the late six years, were so bad.

Frankly, Friedman even partially recanted his rule-based view of a steady M2 growth target in the 90s as velocity trended upwards. Today, he'd likely support an NGDP target - that's interesting, because John Maynard Keynes told us that we should look primarily at indicators such as NGDP and employment. Another person said something very similar: his name was Ben Bernanke - and trust me when I say that he's far from the classic Keynesian sweetheart.

tl;dr: You can't simply disband Keynes. Literally the current theory of the business cycle - almost everything we know about the short run, which is pretty much where we are and have been, save for maybe the Great Moderation (which was probably a fluke, to be honest), is predicated on Keynes.

That said, Friedman is right on fiscal policy, regulation, the role of the federal government, etc., though a monetary policy rule would be disastrous. I'm not even sole on an NGDP futures market as the guidepost for policy.

I thought that the business cycle was Hayek.
And yes, I do support his view on the influence of Aggregate Demand; I just disagree with the policies that he espoused to get there. Still, Friedman remains my favorite economist. And why do you say that a monetary policy rule would be disastrous? And what do you mean by a monetary policy rule?
ResponsiblyIrresponsible
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5/15/2015 6:15:03 PM
Posted: 1 year ago
At 5/15/2015 5:59:05 PM, Cowboy0108 wrote:
I thought that the business cycle was Hayek.

No, the Austrian business cycle theory suggests that (a) markets are flexible enough such that wages and prices adjust relatively quickly and (b) that recessions are caused by shocks to technology, and are necessary to "purge the rottenness from the system." The same liquidationist view advocated by Andrew Carnegie during the 20s - mind you, one that Milton Friedman forcefully condemned - that wages and prices should find a bottom (and let there be pain and suffering) was pushed by Hayek. It's been ripped to shreds by recent history.

And yes, I do support his view on the influence of Aggregate Demand; I just disagree with the policies that he espoused to get there.

Which policies? At the zero rate bound he's a looney bird - in fact, he almost becomes Hayek. In normal circumstances, he wanted the Fed to intervene aggressive to ameliorate shocks. That sounds fairly reasonable to me.

Still, Friedman remains my favorite economist. And why do you say that a monetary policy rule would be disastrous? And what do you mean by a monetary policy rule?

There are a few variations of a policy. Friedman wanted to set a constant growth target for, say, M2 - which he admitted was dumb, because we care about the aggregate, NGDP, or MV = PY, and shocks to velocity can distort the entire aggregate if we're only focusing on movements in M.

Recently, policy rule discussions have taken the form of the Taylor Rule, which is:

i = pi + r + .5 (pi - pi*) + .5 (y - y*)

i = nominal federal funds rate
pi = current inflation rate
r = Wicksellian equilibrium real rate
pi* = inflation target, 2 percent
y = log real output
y* = log real potential output

In a nutshell, it's a policy framework - which, in reality, is a nice benchmark, but not much more - that says that the policy rate should react to deviations of output from potential and inflation from target. That sounds great in theory, but there a multiplicity of problems with how overly simple and rigid that actually is - which are most pronounced at times of financial stress (i.e., when policy intervention is most critical):

(a) the Wicksellian equilibrium real rate is time-varying
(b) this focuses on the operating target, when the goal variable (inflation, NGDP, employment, take your pick) is what actually matters
(c) what really matters is the spread between the real FFR and the Wicksellian, not what the actual nominal FFR is
(d) the nominal FFR can't go (that far) below zero, so this breaks down at the zero rate lower bound
(e) it eliminates the independent role for forward guidance - there's research by Bullard and Iusepi from the St. Louis Fed to that effect. Forward guidance is pivotal at the ZLB because management of expectations is *the* most important policy tool - and one that is even more important at the ZLB - because long-term rates are an aggregate of short rates, and spending, investment, and hiring decisions are a function of inflation/NGDP expectations. Even outright asset purchases would be far less credible, and their effects muted, without a stable, credible policy of forward guidance
(f) liftoff would be a nightmare - Taper Tantrums galore. I don't even want to look at fed funds futures contracts if we actually modeled policy by a Taylor Rule. Heck, even the bloody SEP dot plot could conceivably screw with financial markets. They're extremely fickle, which brings me to my next point
(g) Policy needs to be flexible and to react to incoming data, but a Taylor Rule would necessitate basing policy on forecasts - so even data releases would move asset prices, which would result in a greater degree of uncertainty which itself is an AD shock (Leduc and Liu have a great paper on that, if you're interested)
(h) We don't know what the actual NAIRU or potential output level are - and both change regularly.
(i) The composition of the FOMC changes regularly; do you really want to change the policy rule every year?

There's probably more - but that ought to do it.
~ResponsiblyIrresponsible

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ResponsiblyIrresponsible
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5/15/2015 6:19:16 PM
Posted: 1 year ago
Oh, and if you actually were to input the data into virtually any formulation of a Taylor Rule, the nominal policy rule comes out to about 1 percent - that's ludicrous, especially when trend output is likely only *temporarily* depressed, and will find its old trend line somewhere after various headwinds (deleveraging, etc.) abate.
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Cowboy0108
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5/15/2015 6:52:21 PM
Posted: 1 year ago
At 5/15/2015 6:15:03 PM, ResponsiblyIrresponsible wrote:
At 5/15/2015 5:59:05 PM, Cowboy0108 wrote:
I thought that the business cycle was Hayek.

No, the Austrian business cycle theory suggests that (a) markets are flexible enough such that wages and prices adjust relatively quickly and (b) that recessions are caused by shocks to technology, and are necessary to "purge the rottenness from the system." The same liquidationist view advocated by Andrew Carnegie during the 20s - mind you, one that Milton Friedman forcefully condemned - that wages and prices should find a bottom (and let there be pain and suffering) was pushed by Hayek. It's been ripped to shreds by recent history.

And yes, I do support his view on the influence of Aggregate Demand; I just disagree with the policies that he espoused to get there.

Which policies? At the zero rate bound he's a looney bird - in fact, he almost becomes Hayek. In normal circumstances, he wanted the Fed to intervene aggressive to ameliorate shocks. That sounds fairly reasonable to me.

Still, Friedman remains my favorite economist. And why do you say that a monetary policy rule would be disastrous? And what do you mean by a monetary policy rule?

There are a few variations of a policy. Friedman wanted to set a constant growth target for, say, M2 - which he admitted was dumb, because we care about the aggregate, NGDP, or MV = PY, and shocks to velocity can distort the entire aggregate if we're only focusing on movements in M.

Recently, policy rule discussions have taken the form of the Taylor Rule, which is:

i = pi + r + .5 (pi - pi*) + .5 (y - y*)

i = nominal federal funds rate
pi = current inflation rate
r = Wicksellian equilibrium real rate
pi* = inflation target, 2 percent
y = log real output
y* = log real potential output

In a nutshell, it's a policy framework - which, in reality, is a nice benchmark, but not much more - that says that the policy rate should react to deviations of output from potential and inflation from target. That sounds great in theory, but there a multiplicity of problems with how overly simple and rigid that actually is - which are most pronounced at times of financial stress (i.e., when policy intervention is most critical):

(a) the Wicksellian equilibrium real rate is time-varying
(b) this focuses on the operating target, when the goal variable (inflation, NGDP, employment, take your pick) is what actually matters
(c) what really matters is the spread between the real FFR and the Wicksellian, not what the actual nominal FFR is
(d) the nominal FFR can't go (that far) below zero, so this breaks down at the zero rate lower bound
(e) it eliminates the independent role for forward guidance - there's research by Bullard and Iusepi from the St. Louis Fed to that effect. Forward guidance is pivotal at the ZLB because management of expectations is *the* most important policy tool - and one that is even more important at the ZLB - because long-term rates are an aggregate of short rates, and spending, investment, and hiring decisions are a function of inflation/NGDP expectations. Even outright asset purchases would be far less credible, and their effects muted, without a stable, credible policy of forward guidance
(f) liftoff would be a nightmare - Taper Tantrums galore. I don't even want to look at fed funds futures contracts if we actually modeled policy by a Taylor Rule. Heck, even the bloody SEP dot plot could conceivably screw with financial markets. They're extremely fickle, which brings me to my next point
(g) Policy needs to be flexible and to react to incoming data, but a Taylor Rule would necessitate basing policy on forecasts - so even data releases would move asset prices, which would result in a greater degree of uncertainty which itself is an AD shock (Leduc and Liu have a great paper on that, if you're interested)
(h) We don't know what the actual NAIRU or potential output level are - and both change regularly.
(i) The composition of the FOMC changes regularly; do you really want to change the policy rule every year?

There's probably more - but that ought to do it.

Unfortunately for me, I have not learned the Taylor rule in great depth. All I know is that it is a tool for monetary policy. Therefore, all that you wrote looked like French to me.
Now, for the part about Hayek, what is wrong with his business cycle theory? I thought that the business cycle came because the bad businesses need to be purged. What would we do without the business cycle? I like the idea of an economy in equilibrium. Of course, this may just be because I have read into Austrian economics so heavily, and I have only recently started to look into Milton Friedman.
ResponsiblyIrresponsible
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5/15/2015 7:03:03 PM
Posted: 1 year ago
At 5/15/2015 6:52:21 PM, Cowboy0108 wrote:
Unfortunately for me, I have not learned the Taylor rule in great depth. All I know is that it is a tool for monetary policy. Therefore, all that you wrote looked like French to me.

That's all there is to it - you put the data into the equation, and out comes your policy rule.

Now, for the part about Hayek, what is wrong with his business cycle theory? I thought that the business cycle came because the bad businesses need to be purged.

Why would we want to purge them? I mean, the recession was caused by made-to-distribute, hot-potato financial instruments - and those institutions, ideally, would be allowed to go bankrupt, moral hazard aside - but that's by no means typical of the average business cycle.

The crux of Hayek's theory - let prices and wages hit their bottom and markets equilibrate - is on its face absurd. You condemned deflation earlier - this policy is ipso facto deflationary.

What would we do without the business cycle? I like the idea of an economy in equilibrium.

As do I.. which I want aggressive policy measures to respond to an AD shortfall because short-run nominal rigidities and the mystical market mechanism take a long time to get their act together.

Of course, this may just be because I have read into Austrian economics so heavily, and I have only recently started to look into Milton Friedman.

Milton Friedman was opposed to real business cycle theory, lol.
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Cowboy0108
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5/15/2015 8:31:10 PM
Posted: 1 year ago
At 5/15/2015 7:03:03 PM, ResponsiblyIrresponsible wrote:
At 5/15/2015 6:52:21 PM, Cowboy0108 wrote:
Unfortunately for me, I have not learned the Taylor rule in great depth. All I know is that it is a tool for monetary policy. Therefore, all that you wrote looked like French to me.

That's all there is to it - you put the data into the equation, and out comes your policy rule.

Now, for the part about Hayek, what is wrong with his business cycle theory? I thought that the business cycle came because the bad businesses need to be purged.

Why would we want to purge them? I mean, the recession was caused by made-to-distribute, hot-potato financial instruments - and those institutions, ideally, would be allowed to go bankrupt, moral hazard aside - but that's by no means typical of the average business cycle.

The crux of Hayek's theory - let prices and wages hit their bottom and markets equilibrate - is on its face absurd. You condemned deflation earlier - this policy is ipso facto deflationary.

What would we do without the business cycle? I like the idea of an economy in equilibrium.

As do I.. which I want aggressive policy measures to respond to an AD shortfall because short-run nominal rigidities and the mystical market mechanism take a long time to get their act together.

Of course, this may just be because I have read into Austrian economics so heavily, and I have only recently started to look into Milton Friedman.

Milton Friedman was opposed to real business cycle theory, lol.

Yeah, I just got a link to a Milton Friedman book, so I am going to spend some time reading that to really get a grasp of his economic philosophy.
ResponsiblyIrresponsible
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5/15/2015 8:32:00 PM
Posted: 1 year ago
At 5/15/2015 8:31:10 PM, Cowboy0108 wrote:
At 5/15/2015 7:03:03 PM, ResponsiblyIrresponsible wrote:
At 5/15/2015 6:52:21 PM, Cowboy0108 wrote:
Unfortunately for me, I have not learned the Taylor rule in great depth. All I know is that it is a tool for monetary policy. Therefore, all that you wrote looked like French to me.

That's all there is to it - you put the data into the equation, and out comes your policy rule.

Now, for the part about Hayek, what is wrong with his business cycle theory? I thought that the business cycle came because the bad businesses need to be purged.

Why would we want to purge them? I mean, the recession was caused by made-to-distribute, hot-potato financial instruments - and those institutions, ideally, would be allowed to go bankrupt, moral hazard aside - but that's by no means typical of the average business cycle.

The crux of Hayek's theory - let prices and wages hit their bottom and markets equilibrate - is on its face absurd. You condemned deflation earlier - this policy is ipso facto deflationary.

What would we do without the business cycle? I like the idea of an economy in equilibrium.

As do I.. which I want aggressive policy measures to respond to an AD shortfall because short-run nominal rigidities and the mystical market mechanism take a long time to get their act together.

Of course, this may just be because I have read into Austrian economics so heavily, and I have only recently started to look into Milton Friedman.

Milton Friedman was opposed to real business cycle theory, lol.

Yeah, I just got a link to a Milton Friedman book, so I am going to spend some time reading that to really get a grasp of his economic philosophy.

That's a good idea - be sure to supplement it with some Keynes!
~ResponsiblyIrresponsible

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