So one of my big takeaways from Friday’s debate is that the difference between Austrians and New Keynesians rests squarely on the questions of capital consumption and market power.

I think we both accept that the Federal Reserve can create booms. I am not entirely clear on the mechanism by which Austrians suggest that the Federal Reserve has control over the short term interest rates. That is, why aren’t federal reserve actions immediately undone by the bond market and movements in the price of real goods and services? Why isn’t money a veil?

I think – but am open to clarification – that something akin to sticky-prices is accepted. The motivation for this I believe is real costs of price changes. That is, information is expensive and if you keep moving prices you raise the informational costs that your customers face.


So if we accept sticky-prices and we accept that the Federal Reserve can indeed alter short term interest rates, nearly at will, then what is left to argue over?

Well, its why movements in short rates cause booms. In the New Keynesian story its that firms have market power and thus could be producing below the socially optimal level. Thus a boom at least in theory could optimally employ more resources and make society genuinely wealthier.

In the Austrian story its that the movements in short rates distort the allocation of capital and indeed lead to capital consumption. That is, firm will neglect maintenance on some capital and divert resources towards building new capital.

This is KEY because it means that what looks like increases in measured prosperity is misleading. Yes, more people have jobs and more factories are operating but they are only doing so by neglecting maintenance.

Eventually this will come around to bite us all in the rear.

There is of course, more to the Austrian story and more to the New Keynesian story than just that, but I think in terms of conflict, that’s all that matters. Moreover, if there is no market power then the entire New Keynesian structure collapses. You can hang on to some other beliefs but its really got to seem like pushing the economy out of its natural competitive equilibrium is a bad idea.

On the other side without capital consumption the Austrian structure would seem to collapse. You can keep some of the other elements but your baseline now has to be that prosperity does indeed increase during booms.

This is not to say that third alternatives do not exist in which money induced booms are either potentially good or never good, but that these two stories about why, depend crucially on these elements.