Depressions Cause a lot More Pain than Benefits-Becker

Source : The Becker-Posner blog

Some older theories of business cycles-usually associated with the "Austrian" school of economics- claimed that recessions and depressions were useful in helping to remove the poison from an economy that builds up during good times. For example, weaker companies are the first to go when the demand for an industry's product falls during recessions. Employees who are allowed a lot of slack during good times are forced to work harder during recessions in order to keep their jobs.

Pr Becker,

Thanks for mentioning the ABCT. It is better to see this theory discussed than absent of the mainstream discussion. However, it is ofter misunderstood and misrepresented. Several points should be clarified :

- the most frequent confusion concerns overinvestment vs malinvestments, as in Krugman's "hangover thoery"

- the recession is unavoidable - rather than "good" or "useful" - because the long-term projects that have been started during the boom cannot physically be completed under current consumption trends

- the bust is the moment when most people realize that their expectations cannot and will not be met, and therefore revize their expectations

- the recession is the phase during which the allocation of ressources adjusts to these new expectations

- the depression - which is NOT part of the ABCT - is what happens as a secondary phenomenon when measures such as wage and price controls, public works, bailouts, etc. are enacted

The overinvestment vs malinvestment confusion can be clarified by reading these essays.

That the recession is unavoidable is the crux of the matter, and not obvious at first. Mises provides a parable with house builders to illustrate this idea. It is presented in a simple fashion here.

The one good thing about the bust is that people start having realistic expectations. It is useful in that it allows them to start projects which are moke likely to be successful. Had their expectations remained unsustainable due to the monetary distorsion of relative prices and interest rate, they were likely to fail en masse.

The recession is also "good" unless one considers that production should not meet consumer preferences. This would be the case if no adjustments took place in the allocation of labor and investments. These adjustments have no reason to take much time. But if a major recession is defined as an extended period with more than 9% unemployment, this is an entirely different issue. Any definition is acceptable as long as we know which one is being used.