Monday, September 17, 2012

A Short Logico-Conceptual Derivation of the Austrian Prescription Against Recession

Value destruction is the depletion of the sources of value. Value conservation is the replenishment of the sources of value. Value creation is value conservation plus the addition of new sources of value.

Income can be allocated along the following three margins: consumption expenditures, savings, and hoardings. These three margins correspond, respectively, to the following three uses: consumption, investment, and hedging against uncertainty.

Consumption is utility-increasing value depletion, as opposed to waste, which is utility-decreasing value depletion. Investment is value conservation (capital reaccumulation) or value creation (capital accumulation).

In the world of imperfect information, investment requires entrepreneurship (successful uncertainty bearing), which, in turn, requires the existence of generally reliable price signals (the preconditions of sound economic calculation) and capitalist regime certainty (reliable institutional protection of property rights and contracts).

An economic recession is a period marked by systemic, large-scale waste (capital consumption and malinvestments) caused by the preceding distortion of price signals, especially interest rates (signals that coordinate production over time, i.e., coordinate savings with investment).

To get out of a recession, malinvested and overconsumed capital has to be, respectively, reinvested and reaccumulated, which requires entrepreneurship and its preconditions, listed two paragraphs above.

Uneven inflation of the money supply in the world of imperfect information falsifies economic calculation, discourages saving (and thus investment), and distorts the intertemporal structure of production. Deficit spending weakens the system of reliable institutional protection of property rights and contracts and diminishes the value of hoardings, thus creating regime uncertainty.

Hence, inflation and deficit spending discourage investment and prevent entrepreneurship, consequently prolonging recessions, as well as encourage capital consumption and malinvestment, consequently deepening recessions.

Qua policy advisors, Austrian economists suggest that the things to do in a recession is to avoid inflation and eliminate deficit spending. Qua policy advisors, (New) Keynesian economists suggest that the things to do in a recession is to generate inflation and engage in deficit spending.

Thus, qua policy advisors, Austrian economists suggest getting out of recessions via value conservation (and eventual value creation), while (New) Keynesian economists suggest prolonging and deepening recessions via continued value depletion. QED.

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