Hayek & Stephen Williamson on Money Bubbles & “Shock” Applification

(htlm link problems will be fixed when I am able to troubleshoot the issue)

A central part of Hayek’s macroeconomics has not gotten enough attention (although it has http://hayekcenter.org/?p=2954 has not been completely ignored; see also http://zerohedge.blogspot.com/2009/05/chasing-shadow-of-money.html In several places Hayek discusses how reiterative processes involving credit and debt in conjunction with assets valued across time can expand the supply of money and money substitutes while perceptions of risk decline and the demand for money balances themselves decline in the wake fluctuations in market conditions accompanied by bandwagon shifts in optimism (see Book IV of Monetary Theory and the Trade Cycle and the 2nd edition of Prices and Production, etc.). (These wave may or may not be related to central banking policies, although under current institutional arrangements they are not completely independent of those policies, conditioned via international flows of money, goods and credit.)

These Hayekian themes have been picked up by economist Stephen Williamson, wrting in the wake of recent argument by http://newmonetarism.blogspot.com/2012/02/three-views-of-state-of-economy_12.html St. Louis Fed President James Bullard on problems with the notion of “potential GDP”. Williamson describes what he calls http://newmonetarism.blogspot.com/2012/02/amplification-and-indeterminacy.html shock “amplification” via money bubbles:

“A piece of the price of houses is always due to a type of “monetary bubble.” Equity in a house is collateral which can be used by the homeowner to borrow; the mortgage on the house can be packaged as a mortgage-backed security, and that security can be used in financial exchange, and as collateral, perhaps multiple times. Thus, through an amplification effect, the housing collateral potentially supports a very large quantity of credit, and that feeds back into housing prices. The financial crisis was about incentive problems that caused the monetary bubble to be larger than was socially optimal, and once financial market participants caught on, that piece of the bubble burst.”

This, of course, is simple an alternative causal pathway exhibiting the pattern previously laid out and explained by F. A. Hayek his Monetary Nationaism and the Trade Cycle and in his Prices and Production.

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It is probably no exaggeration to say that economics developed mainly as the outcome of the investigation and refutation of successive Utopian proposals. — F. A. Hayek

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