One of the assumptions you state in your abstract is: “This paper demonstrates an entrepreneur may simultaneously classify a capital good into several orders, as orders of goods are defined by Austrian economists.”

Austrians understand that uniform goods such as say gasoline can serve as inputs at different stages of production. There is no need for entrepreneurs to “classify” such a good into any particular stage. One can use such a capital good at any stage. It the actual use of the good by a particular stage that makes for the Hayekian triangle.

Thus if interest rates are low thus spurring an increased investment in commodities like copper then this will tend to increase the consumption of gasoline for mining copper.

Obviously, one can redirect any remaining gasoline to another stage quickly. However the gasoline that was consumed is consumed at a particular stage. In doing so there is a conversion of one capital good to another. Gasoline plus mining equipment and physical mine gets converted to ore at stage one, gasoline plus ore and smelting equipment gets converted to copper at stage two, etc.

Other capital goods are more specialized. You might have a specialized machine that beats the ore that is made of steel. During a boom the quantities of such machines may have been increased. This requires that steel be diverted from other later stages of production (as with the gasoline).

Unfortunately in this case it is not so easy to correct this diversion without more capital input. The machinery would need to be melted down to convert it to some other stage of production as it is unsuitable for use in the other stages in it’s current form.

Since one of the main assumptions of your paper about Austrian Business Cycle theory is incorrect I believe your paper to be of no consequence.

Roger W. Garrison, Auburn University

In his dismissive response to my recent Freeman article (“Mainstream Macro in an Austrian Nutshell,” May 2009), Brad DeLong provides some arithmetic that supposedly weighs against the Austrian theory of the business cycle as a plausible basis for understanding the current recession. He argues that the estimated $2 trillion worth of housing stock write-downs and the consequent construction slow-downs imply that the unemployment rate during the next decade should be higher by only 0.6%. On the basis of this calculation, he announces that the Austrian theory “just does not work.”

The Austrians might well be similarly dismissive of DeLong’s announcement, but it is worth pointing out that the differences between DeLong and the Austrians are not to be resolved by doing the math but by understanding the theory. Tellingly, DeLong has overestimated and, at the same time, underestimated the significance of the housing bubble in the Austrians’ view of the current recession….

For the rest of the rejoinder see
http://www.auburn.edu/~garriro/delong.htm

It will not only reduce construction employment below trend. It will also reduce employment in industries related to construction, those that supply it, for example. There are also other areas that saw a boom, banking for example, which is also contracting causing direct and indirect job losses.

Robert Vienneau: “I might as well point out my refutation of Garrison, linked to by my name.”

Robert Vienneau points to the reswitching and substitution problems with Austrian economics. Certainly these exist.

Capital may be a Giffen good for businesses. In that case if the central bank subsidize it by reducing the interest rate businesses may actually use less of it.

Also, capital goods may also be substitutes for consumer goods. Ranks of capital goods of different orders may be irrelevant if they can substitute for each other.

Though these two theoretical arguments are correct they clearly don’t apply to the real world. (They do demonstrate nicely though that Mises’ austrian economics isn’t entirely a priori).

More pertinent to his “answer” above, however, is that, having no theory of the boom, he can’t disaggregate the bust. He can’t distinguish between the downturn inherent in the liquidation of malinvestments and the secondary downturn that can follow from a government response which is unnecessary (despite his assertion that “we may not have the choice” and so something must be done), politically charged, and inconsistent. I can’t say that I follow his figures or the assumptions behind them, but he does seem to be implying that the Austrian theory should account for the aggregate “facts”, and whether they are a result of primary or secondary downturns is (to him) quite irrelevant.

The problem for any reasonable discussion of all this is that it is constrained by the context of a central bank. But nothing the bank can do is right. If it does nothing or tightens, then we have the 1930s scenario. If it loosens, then, being the blunt instrument it is, it inevitably ends up shoring up activities that need to be liquidated and sets the scene for major inflation later. In a free banking regime, each bank could expand or contract according to its appraisal of its circumstances (and you wouldn’t have had the problem in the first place). But if you talk about free banking, you’re immediately dismissed as not being in the real world.
DeLong’s context, in contrast, is that we’re in a crisis (never mind how we got there or what the components of this crisis are) and we must attack it bluntly with the politicized tools at hand. But if that’s what carries the day as pragmatic analysis, then the real world is in real trouble.

The only explanation I have seen that focuses on or even discusses the cause of the boom in the central bank-engineered expansion of credit is the Austrian theory. The Keynesians completely ignore it. Evidently it doesn’t fit within their IS/LM apparatus, which was pretty much repudiated by Hicks and is smashed to smithereens by Minsky in his book on _John Maynard Keynes_. See also the critique of it in the Econ. Journal Watch article linked to in the bibliography of the Wikipedia piece on IS-LM.

DeLong has a basic problem with getting the facts right, regarding both the Austrian theory and its application to the economy.

But it now looks as though this recession is going to raise unemployment by an average of 4% for 3 years–20 times as great as the overinvestment-and-sectoral-shift Hayekian story says.

You have a basic problem with your math.