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“The Application of Austrian Business Cycle Theory: The Great Depression and Recent Cycles in the US and Japan” by Gregory B. Christainsen*
* Professor of Economics, California State University, Hayward (CSUH) and Director, CSUH-San Jose State University Executive MBA program, Singapore. This paper was prepared for the annual meetings of the Association for Private Enterprise Education, Las Vegas, April 6-8, 2003. E-mail: firstname.lastname@example.org
“The Application of Austrian Business Cycle Theory: The Great Depression and Recent Cycles in the US and Japan” “There is no means of knowing beyond question how far this recent rise in stock prices represents excessive speculation and how far [it represents] a readjustment of values to increased industrial efficiency and larger profits.” -- from the minutes of the meeting of the Federal Open Market Committee of the Federal Reserve, April 1928 In December 1996 Federal Reserve Chairman Alan Greenspan asserted that American stock markets were experiencing “irrational exuberance”. At that time few observers could have foreseen that, as measured by the Standard and Poor’s Composite Index, stock prices would eventually rise more than 70 percent above the level that they had already reached when Greenspan uttered those memorable words. This paper is devoted in part to explaining as succinctly as possible the role played by Greenspan and his colleagues as equity and other asset prices rose to stratospheric heights. The collapse of the bubble in asset prices was followed by a recession and a whiff of deflation in 2001. Developments in America came on the heels of, and in some ways mirrored, events in Japan. There, too, a spectacular bubble in asset prices was followed by a recession and deflation. Finally, both the recent US and Japanese experiences call to mind the Great Depression, which itself involved a deflation that followed the bursting of an asset bubble. This paper will discuss some of the similarities and differences among the three episodes. Austrian business cycle theory, as put forth by Ludwig von Mises (1912 ) and Friedrich Hayek (1931 ), will be used to help organize the discussion. The theory bears some resemblance to monetarism, but as we shall see, Austrians are more
directly concerned with the possibility that movements in the prices for capital assets will diverge from those for consumer goods. Austrian theory is also used here for the way in which it connects recessions and deflationary pressures to a preceding boom. It is not claimed that the theory offers a complete explanation of the various episodes, but as the world economy struggled through the last two years, some mainstream publications (e.g., The Economist, 28 September 2002) at least gave it renewed respectability. In its simplest form, the theory begins with the observation that, especially in the short term, Central Bank injections of money are not neutral with respect to the allocation of resources.1 Indeed, such injections may misdirect resources insofar as they encourage activities that are inconsistent with people’s underlying preferences. Of particular
importance are people’s preferences for current consumption as opposed to saving. If people voluntarily save, they willingly forego current consumption and resources become available for capital investment. The capital investment generally enhances productivity and makes possible the production of more consumer goods in the future. The saving (and investment) presumably has more value than additional goods for current consumption, or else people would simply spend of all of their incomes now on consumer goods. If, on the other hand, capital investment is financed by injections of fiat money, the Central Bank may be diverting resources from consumption that would be more highly valued than additional capital goods. In other words, resources may be misdirected. The misdirection of resources is thus connected to the fact that money injections increase the supply of funds in financial markets beyond the level of people’s voluntary savings. At least early in the process, the injections of money drive interest rates lower
and make capital investment more attractive. For a given change in interest rates, the net present values of investments whose payoffs are of a long-term nature increase relative to those of shorter-term ventures.2 Prices for new capital goods are bid up relative to those for consumer goods. Already-existing capital assets, including stock shares and real estate, also go up in value. In this process, inputs, most notably labor, are drawn into production that is more capital-intensive than it otherwise would be. A boom led by the increased capital investment results in increased incomes. Upon receiving their incomes, people can be expected to exhibit at least approximately the same propensity to consume as they would have in the absence of the injections of money. If spending for current consumption (as opposed to capital goods) is thereby re-emphasized, the prices of consumer goods will now move up relative to those for capital items and eventually restore, at least approximately, their former position on a relative basis. As the prices of consumer goods rise on a relative basis, resources are shifted back toward their production.3 A tilt toward the production of new capital goods can thus be maintained only as long as the supply of money continues to be accelerated. If the acceleration just levels off, production will start to shift away from capital goods and back toward consumer goods. If there is a significant deceleration in the money supply, there may be a shift away from capital goods that is rather violent.4 If a large-scale shift of resources out of the capital goods sector must eventually occur, it cannot be accomplished without frictions, given less-than-perfect mobility of both labor and capital. There may then be excess capacity concentrated in the capital
goods sector and unemployment of some of the associated labor during the transition process. In 1931 Hayek formally introduced the Austrian theory to the English-speaking world in four lectures at the London School of Economics. Part of his 1974 Nobel Prize citation referred to this early work. In subsequent seminars at the London School during the 1930s he and others also discussed the possibility of what they called “secondary deflation” (American Enterprise Institute 1975, O’Driscoll 1977). They were speaking at a time when Central Bank activity was mixed in with the remnants of the international gold standard, which included fixed rates of exchange among national monies. If the supply of one nation’s money were expanded while another nation’s was not, there might have to be a later contraction in the first nation’s money supply, and an accompanying deflation, to maintain the fixed rate of exchange. A “secondary deflation” could also develop insofar as the misdirection of resources would leave banks with large numbers of nonperforming loans. Bank
customers might then seek to withdraw funds out of concern for the safety of their deposits. However, mass withdrawals would reduce the money supply and cause prices to fall. There may in any event be an increased demand for cash balances during a time of financial uncertainty – on the part of banks as well as other players in the private sector. If banks hold additional reserves, the money supply again shrinks and prices fall. Insofar as people or companies have an increased demand for cash balances relative to income, it translates into a lower velocity of money, less spending, and once more, a fall in prices.
If deflation begins, it may accelerate because, as prices fall, the purchasing power of each dollar increases, which provides an additional incentive to hold cash balances. The problems of banks may also multiply because, insofar as the real value of nominal debt increases, it becomes more difficult for borrowers to repay loans. Hayek originally argued that in the case of a secondary deflation, events should simply be allowed to run their course. He later took the position that an unanticipated deflation causes such harm that a Central Bank should seek to mitigate it via additional creation of money even though new money injections could themselves cause some misdirection of resources (American Enterprise Institute 1975). With Austrian theory in mind let us now look, however briefly, at the runup to the Great Depression. The monetary base grew at only a 2.1 percent average annual rate from July 1922 to July 1928, but, at the same time, the M2 money supply grew at an average annual rate of 5.2 percent (Friedman and Schwartz 1963, appendices).5 A depositor shift from checking accounts to savings accounts, which had far lower reserve requirements, caused a significant increase in the M2 money multiplier during part of the period. From April 1927 until April 1928 there was a significant conversion of currency into deposits and the money multiplier increased at an even faster rate. The overall money supply thus rose 5.8 percent in the 12 months to April 1928, despite zero growth in the monetary base.6 Stock prices, as measured by the Standard and Poor’s Composite Index, increased by 125 percent from July 1922 to July 1928. The statistics for real estate are less reliable, but there is no doubt that it boomed as well, especially from 1924-26. Considering just the period from April 1927 until April 1928, stock prices increased 37 percent. By
September of 1929 the stock market had gone up an additional 61 percent. The market crashed the following month. From April 1928 to August 1929 both the monetary base and M2 actually contracted slightly as the Federal Reserve sought to rein in the bubble in stock prices. According to the National Bureau of Economic Research, business activity started to decrease during the summer of 1929. Note that, whereas the stock market usually anticipates turns in the business cycle, it did not decline meaningfully on this occasion until a recession was actually beginning. Incredibly, the Federal Reserve shrank the monetary base by 3.9 percent from September 1929 until October 1930, and the M2 money supply fell by 2.8 percent during that time. In November 1930 the monetary base started to increase, but the fall in M2 accelerated. Bank runs that originated in Midwest farming areas precipitated the accelerating decline in M2. As Vera Smith (nee Lutz), a student of Hayek, has noted, the runs spread to New York banks as it was realized that some of these rural banks had to draw on correspondent accounts that they had with New York counterparts (Smith 1936 ). Banks starting holding extraordinary reserves beginning in 1931. From the middle of 1922 until the middle of 1930 there was hardly any variation in the Consumer Price Index. Thereafter, prices for consumer goods started to decline rather rapidly. They fell a full 10 percent from March 1932 to March 1933 as the secondary deflation climaxed. If one considers a broader price index that includes asset prices, prices rose at a 1.8 percent average annual rate from 1922-29 (Rothbard 1975, 154) and then fell decisively as the stock market crashed. Production fell until 1933.
In the case of Japan the money supply as measured by the closely watched “M2 plus CDs” grew from 7.4 to 9.2 percent each year from 1982-86 according to the Bank of Japan (www.boj.or.jp/en). During the decade Japan was widely proclaimed to be an economic superpower, one that, in many ways, was now “beating” the United States. After the 1987 Louvre Accord decision to weaken the Japanese yen vs. the US dollar, Japanese money growth ballooned to double-digit rates through 1990. The average daily closing value for the Nikkei 225 stock index stood slightly above 8000 for the year 1982. The average for 1989 was almost 39000. Stock prices fell back and then completely collapsed as money growth was cut to 3.6 percent during 1991. Prices for real estate followed a pattern that was similar to the one for stock prices. Since 1991 the year-over-year change in the money supply has never again exceeded 4.0 percent, and it has actually been negative during some 12-month periods. The Nikkei index still had an average daily closing value above 22000 in 1991, but by the end of 2002 the index was almost back to 1982 levels. As in the US during the runup to the Great Depression, consumer prices were quite stable as the bubble in asset prices developed. Despite rapid money growth, the average annual year-over-year change in the Consumer Price Index (CPI) was less than 1.7 percent from 1985-1992. As the forces of secondary deflation unfolded, however, the deflator for gross domestic product (GDP) fell during seven of the following 10 years and the CPI fell rather consistently after 1997. Real growth in the Japanese gross domestic product has been essentially zero since 1991, and the year-over-year change in real GDP has been negative on three occasions (www.boj.or.jp/en).
Commercial banks in Japan were left with mountains of nonperforming loans, and the asset-collateral that they have been able to seize is not worth nearly as much now as it was several years ago. In contrast to the United States in the early 1930s, the Japanese government has maintained an intention to insure the safety of bank deposits, but that guarantee became less credible as time wore on. Moreover, a high propensity to save, depressed investment demand, and a lack of inflation resulted in extremely low interest rates (measured in either nominal or real terms). Given a low crime rate, many Japanese concluded that it was better to keep money at home than at commercial banks. Home safes have constituted one of the few growth industries of recent years. The country thus did not experience much in the way of true bank runs, but there were significant withdrawals from institutions. In addition, banks became reluctant to lend to new customers and generally preferred to roll over the debt of established borrowers. Social and legal norms are such as to make forced bankruptcies relatively rare. Bad loans are written off only slowly. In the more recent US case Chairman Greenspan did, of course, refer to rising asset prices as early as December 1996, but aside from one interest-rate hike in March 1997, the Federal Reserve took no actions that could be construed as restrictive until 1999. In the 12 months to June 1997 the M3 money supply grew 7.5 percent. M2 grew 4.5 percent. The monetary base grew 5.0 percent (www.federalreserve.gov). The
minutes of Federal Reserve meetings (www.federalreserve.gov) reveal an institution that was genuinely concerned about possible inflation, but mostly as it might be reflected in consumer prices or labor compensation, both of which tend to be lagging indicators of inflationary pressure. Moreover, there was growing optimism that technology-led
improvements in productivity were helping to moderate inflationary pressure and might indeed justify higher asset prices than conventional analyses would support. In July 1997 the Asian financial crisis burst on the scene, with some concern that it might affect the US. It became difficult to argue for hikes in interest rates. The growth of the monetary aggregates accelerated further. In the 12 months to March 1998 the monetary base grew 6.4 percent, M2 grew 6.7 percent, and M3 increased more than 10 percent. Two famous monetarists at the Fed, Jerry Jordan and William Poole, argued for rate hikes, but were easily outvoted. Jordan’s remarks in May 1998 deserve special emphasis: “Mr. Jordan…noted that the monetary and credit aggregates had accelerated further from already rapid growth rates in 1997. In his view, these high growth rates were fueling unsustainably rapid increases of real estate and other asset prices…the Committee would face a choice between smaller increases in interest rates sooner versus larger increases later.” [from the minutes of the May 1998 meeting of the Federal Open Market Committee] The government of the Russian Federation further complicated US monetary policy when it defaulted on its debt in August 1998. Shortly thereafter there was the near-collapse of Long Term Capital Management (LTCM), a huge and highly leveraged investment fund. With financial institutions facing the prospect of a ripple of unmet payment obligations, the Fed helped to organize a rescue of LTCM and cut short-term interest rates in both September and October by one-quarter point. By November 1998 conditions in financial markets had largely calmed down, but the Fed acted aggressively to cut rates yet again. Jordan dissented from this decision and argued that the Fed would be unleashing a dangerous increase in new spending. He asserted that the growth in liquidity necessary to keep rates at the targeted level could be very inflationary.
In the 12 months to December 1999, M2 grew 6.2 percent and M3 grew 8.3 percent. However, there was clearly an increased demand for liquidity during the latter part of 1999 due to the impending change of computer systems to Y2K and the malfunctions that many people feared. On the other hand, even before the final quarter of 1999 one sees a monetary base that was growing much of the time at double-digit rates. Short-term interest rates were hiked on three occasions as the year progressed, but the increase in rates occurred primarily because a boom-induced increase in the demand for funds was now outstripping a still-rapidly-growing supply. From 1993-99, gross private domestic investment as a share of GDP increased by more than three percentage points, and real spending on new capital goods grew by more than nine percent per year (www.bea.gov). The investment boom was even more pronounced if one counts durable (long-term) consumer goods as an “investment” item. From an Austrian point of view, however, this boom was cause for alarm rather than celebration because money creation rather than voluntary savings financed a good part of it. After January 1 of Y2K the Fed mopped up some of the liquidity that was created in the final quarter of 1999. M2 and M3 then grew at close to their 1999 rates, but even after the monetary base started growing again, its rate of increase was much lower than it had been in the previous year. From March until December 2000, the base grew only 2.9 percent at an annual rate. Short-term interest rates were hiked another full point during the first half of the year, culminating in a panicky-looking half-point increase in May 2000. Thus, Jerry Jordan was borne out: significant rate increases were now necessary to
combat inflation in light of the fact that smaller increases had been shunned earlier.7 Whether the rate increases needed to be quite as large as they were is debatable. After subtracting the impact of volatile food and energy prices, the personal consumption deflator, Alan Greenspan’s favorite price-level measure, never did show an four-quarter increase of more than two percent during the episode, although it appears to have accelerated late in the process.8 Led by a tumble in the NASDAQ index, a sustained fall in stock prices began in March 2000 and by the end of the year President Clinton and President-elect Bush were arguing over who would be to blame for a forthcoming recession. (Neither one had much to do with it!) Internet companies – “dot.com’s” -- were especially hard hit insofar as many were established on a foundation of cheap equity capital and optimism about long-term revenues and earnings. Given initial projections of several years of negative cash flows and long payback periods, their fortunes were especially likely to reverse when the Fed concluded that it could no longer act in an accommodating fashion. In 2001 the Fed embarked on an unprecedented set of interest rate reductions and re-accelerated the monetary base. In the aftermath of the terrorist attacks of September 11, the annualized three-month growth rate for the monetary base was more than 25 percent. Funds were drained from the system thereafter, and an enduring slowdown in money growth, however measured, led to talk of a faltering recovery during 2002. According to the GDP deflator (www.bea.gov), there was one quarter of deflation in the fall of 2001, but no serious “secondary deflation”. The producer price index, which is reported on a monthly basis (www.bls.gov), showed declines on multiple occasions, but it does not include services, whose prices continued to increase.
Several factors averted a serious deflation. First, the Federal Deposit Insurance Corporation stands by to protect bank deposits, and there were no bank runs. Second, the American financial system has become largely securitized, with bank loans now accounting for only about 20 percent of all financial assets, down from more than 50 percent in decades past. The deregulation of interstate branch banking has permitted banks to diversify their loan portfolios, and banks have improved methods for managing and transferring risk. Finally, the Federal Reserve was far more aggressive to react to deflationary signals than the Fed of the early 1930s or the Bank of Japan in the 1990s. The Fed surprised the markets with a last half-point cut in rates in November 2002. In the three months to December 2002, the annualized growth rate of the monetary base was back above five percent. M2 growth was above eight percent and M3 growth was above nine percent. The outlook is thus for continued economic recovery, but from December 1994 to December 2002 the monetary base grew at an average annual rate of 6.3 percent, and the Fed will still need to contend with incipient inflation pressures down the road. Shortterm interest rates, some of which are negative in real terms, will have to increase, a prospect that should worry many homeowners with adjustable rate mortgages. With stock prices well below their peak, the bigger bubble issue now thus concerns real estate. House prices nationwide are 10-25 percent above their long-term trend line, depending precisely on how one constructs it.9 Prices for real estate in several major metropolitan areas will have to fall or at least flatten out for awhile until they stand in a more realistic relationship to people’s incomes and other prices. The Fed’s actions
before 2000 and during 2001 undoubtedly misdirected resources in this respect. Commercial real estate has already experienced a slump.
Assessment In the absence of an increase in the quantity of money, improvements in productivity would have caused product prices to fall during the 1920s. Money creation made possible a remarkable stability in consumer prices and contributed to a boom in the stock market. However, there have been other occasions in American history when the M2 money supply accelerated more rapidly than it did during the 1920s, and the monetary base has accelerated more rapidly on numerous occasions. Yet, stock prices remained well behaved during those other episodes. It is therefore difficult to attribute the entire 1920s stock market bubble to monetary factors. A general, and sometimes excessive, optimism about technology and the American economic system also seems to have been at work. The stock market went up 61 percent from April 1928 to September 1929 even as the Federal Reserve curtailed money growth. The curtailment led to what appeared to be an ordinary recession in the summer of 1929, and the stock market then imploded. The perverse policies of the Federal Reserve and the bank runs that began in late 1930 were the main factors that turned an ordinary recession into the Great Depression. Politicians played a role with the passage of the Smoot-Hawley tariffs, a subsequent increase in tax rates, and vociferous calls for businesses not to reduce wage rates during an economic downturn (Vedder and Gallaway 1993).
The acceleration in the money supply was more pronounced during the Japanese episode. When the asset bubble burst, banks were left with a gigantic quantity of nonperforming loans, but the system experienced steady withdrawals rather than dramatic runs. Japan thus did not experience a Great Depression, but it has stagnated for a long period of time. Insofar as bankruptcies have been put off, numerous misdirections of resources have still not been corrected. The recent American case saw a notable acceleration in M3 before 1997, but not in the other monetary aggregates. A broad price index that includes asset prices had started to rise at more than a six percent annual rate by that time (The Economist, 2 October 1997). It is worth noting that when the great Irving Fisher made his clarion call for price-level stability (Fisher 1911 ), he had a broad index in mind. It is thus easy in retrospect to say that the Fed should have taken stronger action early on, but again the magnitude of the asset bubble went beyond what could have predicted solely on the basis of the monetary statistics. The Fed later felt constrained by the Asian financial crisis, the Russian default, and the near-collapse of Long Term Capital Management. However, to cut interest rates a total of three times in the fall of 1998 was highly questionable. To be sure, the financial sector looked shaky in September and October of that year, but the outlook had greatly improved by the time of the Fed’s November meeting. Some members of the Fed’s Open Market Committee remarked that it would be easy to rescind the last cut in rates if inflationary pressures surfaced, but after three interest rate increases in 1999 the Fed was still well behind the curve. Foreign investors contributed to the bubble in asset prices. In
the event, the final, and perhaps excessive, actions taken to contain inflation in the year 2000 resulted in only a mild recession the following year. The years from 1995-2000 thus mark one of the most amazing spikes in asset prices in American history, with the future of parts of the housing market still in question. As the bubble developed, and with consumer price inflation and unemployment at low levels, the Federal Reserve chairman acquired a prestige as great as all but a few public officials since the founding of the Republic. Hayek long argued (Hayek 1945), however, that no person, no matter how intelligent, knows enough to centrally-plan economic activity, and this insight even has application to decisions about the proper supply of money. No one can really be sure what the “right” quantity of money is or what the “right” interest rates are, just as no one knows what the right number of pencils is. The main rationale for using markets to allocate resources is to have a mechanism that can “discover” the right quantity for each good or service, based on the separate actions of numerous participants. A handful of Federal Reserve officials sitting around a table can only make crude judgments based on what seemed appropriate or inappropriate in the past and on how the economy presently seems to be performing. Fine-tuning is out of the question. New Zealand offers a quite interesting, but not too radical, policy framework in this context. In the wake of legislation passed in 1989, the Governor of the Reserve Bank must sign a contract that commits him to price-level stability, and an independent review board can remove him if the contract is breached. If there is a bubble in asset values, however, a focus on the stability of consumer prices can be temporarily abandoned in favor of a broader view of monetary policy. A tightening of monetary policy in 1994
might not have occurred as quickly as it did had it not been for a noticeable bubble in Auckland house prices (Christainsen 1997). A more radical proposal would be to carry out, in Hayek’s words, the “denationalization of money” (Hayek 1978). Under denationalization, the Federal
Reserve, as we know it, would be abolished (or at least have its monopoly control over the monetary base abolished). In such a denationalized environment each individual would use his separate knowledge to carry out monetary activity in whatever way he chose, subject to ordinary laws regarding private property and contracts. Legal tender laws that give fiat dollars a special status would be eliminated. Bank reserve requirements and restrictions on the creation of banknotes, such as those that were imposed during the 19th century, would be eliminated as well. People could make contracts in gold, gold certificates, commodity baskets, mutual fund shares – whatever they like. Paper checks or electronic transfers could proliferate in whatever unit of account was adopted. The proper supply of money would be
“discovered” in free markets. No single person or organization would control it, just as no single person or organization controls the supply of pencils. The evidence presented in this paper does not suggest that denationalization would mean the end of all speculative bubbles. The only question is whether denationalization would be less bad in some overall sense than what can be reasonably expected from the Federal Reserve. The irony is that such a proposal used to be openly endorsed by none other than Alan Greenspan (Rand 1967).
1. Mises emphasized a form of the theory that involves money injections by Central Banks, and Hayek’s views are often identified with Mises’. However, Hayek (1929 ) argued emphatically that, given interest rates that are sometimes slow to adjust to changing market conditions, and given changes in banks’ desired ratio of reserves to deposits, it is also quite possible for an expansion of money and credit to arise endogenously (i.e., without deliberate action by Central Banks). 2. It is thus the case that the net present value of an electric power plant, a long-duration investment, is very sensitive to a change in interest rates. However, it should be noted that long-term interest rates tend to fluctuate less than short-term interest rates during the course of a business cycle. The impact of a change in the money supply on the capital micro-structure is therefore not as pronounced as expositions of Austrian theory sometimes suggest. 3. For an empirical test of such claims, see Wainhouse (1985). Wainhouse’s article was based on his doctoral dissertation at New York University. 4. Of course, the deceleration may lead to a more general contraction in economic activity, in which case the consumer sector as well as the capital goods sector will suffer. However, the capital goods sector will suffer first and foremost according to Austrian theory. 5. The monetary base refers to currency held by the public plus commercial bank reserves held with the Federal Reserve. In the 1920s and early 1930s gold was also a significant part of the monetary base. M2 refers to currency held by the public, travelers’ checks, checking accounts, savings accounts, small-scale certificates of deposit (CD’s which have less than $100,000 of face value), overnight Eurodollar deposits, overnight repurchase agreements, and individual money market accounts. M3 refers to M2 plus large-scale CD’s, term Eurodollar accounts, term repurchase agreements, and institutional money market accounts. Austrians are skeptical about claims that there are close and reliable connections between such aggregates and other economic indicators such as gross domestic product. The aggregates are used in this paper as a rough indication of the monetary conditions prevalent during various periods of time.
6. During the summer of 1927 the Federal Reserve cut the discount rate and the interest rate at which it would buy bankers’ acceptances. During the summer and fall it also bought government securities in the open market. However, these expansionary actions were matched by outflows of gold. 7. It should be noted that in December 1998, when all of his colleagues voted to keep short-term interest rates unchanged, Jordan did not dissent. 8. During 1998 the four-quarter increase in this price-level measure was as low as 1.38 percent. In the year to the first quarter of 2001, the index increased 1.93 percent (www.bea.gov). 9. The Office of Federal Housing Enterprise Oversight (www.ofheo.gov) keeps an index of house prices nationwide. The index goes back to 1975. On a long-term basis, nominal house prices have tended to increase by 0.5 – 1.0 percentage points per year more than the personal consumption deflator. Two trend lines for nominal house prices were thus constructed, with percentage changes in the indices for house prices and the personal consumption deflator, respectively, measured in terms of the corresponding changes in their natural logarithms. The first trend line assumes a 0.5 percent per year increase in real house prices, beginning in 1975. The second trend line assumes a 1.0 percent per year increase in real house prices since 1975. Then, the most recent measures of nominal house prices were compared with the trend lines. The difference in the natural logarithm of recent house prices and the corresponding points on the first trend line is about 0.25 or 25 percent. For the second trend line the difference is about 0.10 or 10 percent.
REFERENCES American Enterprise Institute. 1975. “A Discussion with Friedrich Hayek,” Domestic Affairs Studies 39. Christainsen, Gregory B. 1997. “The Role of Forecasting in Meeting Inflation Targets: The Case of New Zealand,” Cato Journal, vol. 17, no. 1. Friedman, Milton and Schwartz, Anna J. 1963. A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press). Fisher, Irving. 1911 . The Purchasing Power of Money. In William J. Barber (ed.), The Works of Irving Fisher, vol. 4 (London: Pickering and Chatto Publishers, 1997).
Hayek, F.A. 1929 . Monetary Theory and the Trade Cycle (Clifton, NJ: Augustus M. Kelley Publishers). Hayek, F. A. 1931 . Prices and Production (Clifton, NJ: Augustus M. Kelley Publishers). Hayek, F.A. 1945. “The Use of Knowledge in Society,” American Economic Review (September): 519-530. Hayek, F.A. 1978. Denationalisation of Money-The Argument Refined (London: Institute of Economic Affairs). Mises, Ludwig von. 1912 . The Theory of Money and Credit (Indianapolis: Liberty Classics). O’Driscoll, Gerald P. 1977. Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek (Kansas City: Sheed Andrews & McMeel). Rand, Ayn. 1967. Capitalism: The Unknown Ideal (New York: New American Library). Rothbard, Murray N. 1975. America’s Great Depression (Kansas City: Sheed and Ward). Smith, Vera C. 1936 . The Rationale of Central Banking [and the Free Banking Alternative] (Indianapolis: Liberty Classics). Wainhouse, Charles E. 1985. “Empirical Evidence for Hayek’s Theory of Economic Fluctuations,” in Barry N. Siegel (ed.), Money in Crisis: The Federal Reserve, the Economy, and Monetary Reform (Cambridge, MA: Ballinger Publishing Company).
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