How do you intepret the business cycle?

[raptix]

How do you see the business cycle, how do you view the financial markets, is the business cycle simply a manifestation of money supply alterations? Tightening, contracting, etc? Or something more/different?

I think its interesting because I'm yet to come to a macroeconomic conclusion of 'what really is the nature of the business cycle'.

Of course this comes out of being someone who likes trading and intermarket analysis is my favorite topic.

Furthermore to expand: What do you think of the business cycle?

Do you entirely comprehend it?

Do you profit from it?

Do you change your life around it?

Any other thoughts on Economics/Finance?

[Blinky]

How do you see the business cycle, how do you view the financial markets, is the business cycle simply a manifestation of money supply alterations? Tightening, contracting, etc? Or something more/different?

I think its interesting because I'm yet to come to a macroeconomic conclusion of 'what really is the nature of the business cycle'.

Of course this comes out of being someone who likes trading and intermarket analysis is my favorite topic.

As far as I know there are two main theories concerning business cycle. One is called neo-keynesian, the other one neo-classical. Neo-keynesian theory contends that business cycle stems from change in money supply and neo-classical theory holds that cycles are elicited by new inventions. If we go deeper, n-kt maintains that in short term market is not efficient (hope that I have chosen right word) and n-ct maintains the contrary, that market is efficient. Non-efficiency of markets is supposed to be caused by "menu costs" and not sufficient amount of information.

In my opinion in this case neo-keynesians are right, however their opinions in other cases are flawed. I think that the cycle change to often to be caused just by new inventions. And new inventions don´t go in lumps but they occur fluently. I have to emphasize too that I don´t agree with neo-keynesians view on solution of business cycles (i.e. state interventions).

I hope I haven´t written some nonsense. It´s quite a long time I have read something about macroeconomy so I don´t know whether I remember everything correctly.

I don´t know what is your question about financial markets related to, so I can´t answer that one.

To your questions:

What do you think of the business cycle?

I have written it above.

Do you entirely comprehend it?

Unfortunately no. Have to read some books about economy again. Human action is waiting...

Do you profit from it?

No.

Do you change your life around it?

Since I am student - no.

Any other thoughts on Economics/Finance?

I would like to know what do you think about efficiency of stock markets (i.e. whether price of stock corresponds to real price of capital that is hidden behind).

[KendallJ]

There is an ARI course specifically dealing with this topic. I have it at home, but haven't listened to it. I bevieve it posits that the business cycle is at least exacerbated if not outright caused by government interference in economic markets. (which is what I would expect their position to be )

It is certainly a topic of interest for me since I work in a highly cyclical industry - chemicals.

[DavidV]

I'm a subscriber to the Austrian Business Cycle Theory.

See Austrian Business Cycle Theory: A Brief Explanation and The Austrian Theory of the Trade Cycle

[Blinky]

I have read something related to the issue recently and I have one problem. If I understand it properly, Austrian economy school holds the same view on the source of business cyles as neo-keynesians do. Both of them think that cycles are caused by alterations of money supply, thus they are called monetary theories.

I have found on wikipedia:

In the Keynesian view, this Austrian theory assumes that the "natural" rate of interest is unique at any given time and cannot be affected by policy. To Keynesian economists, this rate is only unique if the economy is assumed to always be at full employment. If the economy is operating with less than full employment, i.e., with high unemployment above the NAIRU, then in theory monetary policy and fiscal policy can have a positive role to play rather than simply creating booms that necessarily collapse on themselves. It should be noted that, in the Austrian School, the absence of full employment is typically attributed to government interference in the labour markets, such as minimum wage laws, employment regulations, and taxes levied against employers, which prevent the employment market from fully clearing.

I would like to know in which premises both theories differs that one of them concludes that government should intervene and the other one concludes that government should put it´s hands off.

[Capitalism Forever]

How do you see the business cycle, how do you view the financial markets, is the business cycle simply a manifestation of money supply alterations? Tightening, contracting, etc? Or something more/different?

This is how it happens:

1. The economy goes well. (This is the natural state of affairs in a free country.)

2. Keynesian bureaucrats (incorrectly) believe that prosperity causes inflation, so they think they must "cool down the economy" in order to prevent "overheating."

3. They (correctly) believe that raising interest rates and taxes is bad for the economy, so they go ahead and raise interest rates and taxes to achieve the desired "cooling" effect.

4. The rise in short-term interest rates increases the velocity of money (V) and hampers production (Q).

MV = PQ

5. If the money supply (M) stayed constant, both of these factors would lead to an increase in the price index (P)--i.e., inflation. The Fed usually reduces the money supply along with its rate hikes, which helps keep inflation in the single-digit ranges (but does not completely prevent it).

6. The reduction in money supply causes further disruptions in the economy, harming Q even more.

7. A recession ensues.

8. People gradually adjust to the new conditions, and the Fed, seeing the bad economic data, slowly begins to loosen the rope.

9. The economy recovers and things start going well again.

10. Return to step 1.

Do you profit from it?

No, I incur losses because of it.

Do you change your life around it?

I am foced to.

Edited July 28, 2006 by Capitalism Forever

[Blinky]

4. The rise in short-term interest rates increases the velocity of money (V) and hampers production (Q).

MV = PQ

5. If the money supply (M) stayed constant, both of these factors would lead to an increase in the price index (P)--i.e., inflation. The Fed usually reduces the money supply along with its rate hikes, which helps keep inflation in the single-digit ranges (but does not completely prevent it).

6. The reduction in money supply causes further disruptions in the economy, harming Q even more.

I thought that rising of interest rate causes money supply to come down. And that when central bank (Fed or any other) rise the interest rate then M shrinks and it elicits Q to decrease too, because P remains in short term stable.

Inverse proportionality of M and interest rate should be caused by the fact that interest rate is cost of holding the money.

[Capitalism Forever]

I thought that rising of interest rate causes money supply to come down.

The Fed can influence the money supply in any way it pleases through the FOMC, so the one factor that really determines M is the target set for it by the Fed.

And that when central bank (Fed or any other) rise the interest rate then M shrinks and it elicits Q to decrease too, because P remains in short term stable.

P is definitely not stable in the short term. Just observe the prices displayed at any given fuel station for a week or too!

Inverse proportionality of M and interest rate should be caused by the fact that interest rate is cost of holding the money.

But what is the alternative to holding the money? Spending it, either through investing or on consumption. When short-term interest rates are high, people will want to spend their money as soon as possible. Some people will buy CODs and Treasury Bills; others will buy shoes and necklaces--but everyone who has new money on his bank account will be buying something soon. And then the sellers of the CODs and the necklaces will have new money on their accounts, which they will want to spend soon too--the higher the short-term interest rates, the sooner. So what happens is that the money changes hands faster, while staying in the banking system all the time. V is up, while M hasn't changed.

----

(While I always tend to speak about the Fed and dollars, most of what I say applies to other countries as well. I prefer to concentrate on the U.S. because most members of this forum are Americans, or--like myself--want to become Americans. )

Edited July 28, 2006 by Capitalism Forever

[Blinky]

The Fed can influence the money supply in any way it pleases through the FOMC, so the one factor that really determines M is the target set for it by the Fed.

I understand it. And one of the ways of doing so is to change interest rate. What I tried to point at is that rise of interest rate influence money supply (M) rather than velocity of money (V). But to be sincere I don´t know how at the moment.

P is definitely not stable in the short term. Just observe the prices displayed at any given fuel station for a week or too!

I made a mistake. You are right.

But what is the alternative to holding the money? Spending it, either through investing or on consumption. When short-term interest rates are high, people will want to spend their money as soon as possible. Some people will buy CODs and Treasury Bills; others will buy shoes and necklaces--but everyone who has new money on his bank account will be buying something soon. And then the sellers of the CODs and the necklaces will have new money on their accounts, which they will want to spend soon too--the higher the short-term interest rates, the sooner. So what happens is that the money changes hands faster, while staying in the banking system all the time. V is up, while M hasn't changed.

Firstly I have to admit that I confused it a bit and in fact the reason I stated (Inverse proportionality of M and interest rate should be caused by the fact that interest rate is cost of holding the money.) applies to the demand for money and not to money supply. I am sorry, for my mistake.

Secondly I would like to know why do you think that people should prefer to spend money quicklier when interest rates are high. In my opinion they just don´t want to have them cash and they rather have them deposited in bank because it yields some money due to interest rate.

Thirdly I had a look in some book and there was written that V doesn´t change in short term. It does so just when new technologies occur (such as ATM is) or when services of financial institutions improve and so on.

I have to read something about macroeconomy again because I found out that it is much more complex issue than I had thought. It´s terrific how little I remember because two years ago I used to teach my schoolmates economy instead of teacher and now I don´t know even basics...

(While I always tend to speak about the Fed and dollars, most of what I say applies to other countries as well. I prefer to concentrate on the U.S. because most members of this forum are Americans, or--like myself--want to become Americans. )

It´s interesting. Why do you want to become American? Don´t you find other countries better? I have thought about moving to America after finishing university but I concluded that some other country would be probably better choice. I don´t know much about situation in other countries but what I don´t like about America is many stupid laws they have enacted recently and rate of people believing in god. We do have stupid laws here too, but to me they seem to be more tolerable than those in USA. What is the situation in Hungary? As far as I know you had communist party in government few years ago. Is it still true?

[Capitalism Forever]

The Fed can influence the money supply in any way it pleases through the FOMC

I understand it. And one of the ways of doing so is to change interest rate.

No, you've got the cause and effect reversed. The Fed performs open market operations, and that has an effect on the various (short and long-term) interest rates. But the point is that it has a more direct effect on the money supply.

People tend to speak of interest rates and the money supply as if they were one variable, when in fact it is important to distinguish short-term interest rates from long-term interest rates, cash from interest-bearing instruments, as well as a Fed rate cut from a money supply expansion.

Secondly I would like to know why do you think that people should prefer to spend money quicklier when interest rates are high. In my opinion they just don´t want to have them cash and they rather have them deposited in bank because it yields some money due to interest rate.

I would recommend that you re-read my post. I said "spending it, either through investment or consumption." "Some people will buy CODs and Treasury Bills; others will buy shoes and necklaces..." What happens when you invest your money into a Certificate of Deposit? Someone else gets your money. And he doesn't get it because he wants to sit around and do nothing and repay the money with interest 6 months later; he wants to spend it on something!

As I have said on other threads, a penny saved is a penny spent by someone else. So, as far as the effects on the velocity of money are concerned, it does not matter whether you convert your cash into a necklace at the shopping mall or into a COD at your bank: in either case, higher interest rates encourage you to perform such conversion sooner rather than later, and the conversion will contribute to the velocity of money.

Thirdly I had a look in some book and there was written that V doesn´t change in short term.

V has probably been the most mysterious and un-understood of all variables in twentieth-century economics. Some economists think that V is relatively constant; others say that V/Q is constant; and there could easily be some who think that V reflects the influence of God.

My opinion is that, since the short-term interest rate is the cost of holding money in your hand, it is quite reasonable to conclude that higher short-term interest rates will make people more eager to minimize the time money spends in their hands. You may think of money as a potato being passed around among people, with the short-term interest rate being its temperature. The hotter the potato, the faster it will change hands!

It´s interesting. Why do you want to become American? Don´t you find other countries better?

Well, as far as taxation is concerned, Seychelles is quite definitely better, and people are more polite and civil in England, and more receptive to well-meant criticism in Israel--but if you look at the overall picture, I think America has no competitor.

I don´t know much about situation in other countries but what I don´t like about America is many stupid laws they have enacted recently

Can you give a couple of examples?

and rate of people believing in god.

There are certainly more people believing in God in America, but most of them don't want to force their religion on other people (unlike in Europe!) Also, America is very Calvinistic while Europe is terribly Lutheran--and this applies to the Catholics too!

Plus, what really matters is not whether a person believes in God but whether he is guided by an irrational philosophy. I don't have any statistics on the rate of people believing in environmentalism in America vs. Europe, but I have a strong suspicion on where the rate might be higher.

What is the situation in Hungary? As far as I know you had communist party in government few years ago. Is it still true?

Yes, the Socialist Party. They were re-elected this spring. And I'm actually glad they won because the other big party is even worse. The party of the late Prime Minister Antall, who governed from 1990 to 1993 and was one of the very few principled politicians I have seen in my lifetime, got only 5% of the popular vote.

The new Socialist government is doing what I described in step 3 above: raising taxes and interest rates.

BTW, I'm planning to leave Hungary this September.

[raptix]

Thanks for the links GreedyCapitalist and for all your replies.

[softwareNerd]

Do you profit from it?

No, not me personally. However, it might be possible for an expert to profit within a certain context.

To set the context: government intervention is a drag and hurts the economy. Any rational person would want to government to stop intervening and wish for the business cycle to go away.

While one protests against government intervention, one might simultaneously try to predict what the government will do next. For instance, if one is locating a factory, one might consider the probability that the governments at the alternative locations will enact some law that will hurt one's factory. One might, for instance, locate in a state where unions are losing their grip, or where environmentalists aren't making too much headway, and so on. Similarly, if one is deciding between a 30-year mortgage and a 5-year mortgage, one might consider the probability that the government will influence interest rates over the duration of your mortgage.

With readily-traded financial assets (like bonds) there are many professionals who have made a career out of predicting government action. So, even if one is right about a certain government action, if the effect is already widely anticipated, it would typically be "priced in" already. So, as in other such investments, in order to make money, one's forecast has to regularly be better than other forecasts (by other experts). Economists like Salsman sell their forecasts to others who intend to profit by it.

All investors have to consider the long-term effects of government intervention. Not all investors are as interested in the shorter year-by-year cycles. Traders who intend to hold their investments for short periods will typically be more concerned about every Fed move than those who hold investments for longer durations. Warren Buffett is quoted as having said, "If the Federal Reserve Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn't change one thing I do."