Lars Christensen recently posted a question to those who subscribe to ABCT; and he asked it in a very interesting way by juxtaposing a piece of the theory of recessions on the AS/AD model. It is a very interesting post, and I suggest reading it because I am not going to go into too much about it.

The reason I am bringing it up here is because it is an excellent post, but mainly the discussion in the comments section of his post reminded me of why ABCT bothers me so much and why I have not bothered to study it with any seriousness.

I have a lot of trouble choking down the point of “malinvestment,” which its believers are sure to emphasize over the use of something less subjective like “overinvestment”, that supposedly happens because short term nominal rates are forced lower than otherwise would be. I understand that much of the argument is wrapped around objection to the Fed pegging short term nominal interest rates, but might there be other things in the wild that would impact nominal rates?

If one is graphically inclined, such as I am, upon hearing the ABCT syllabus one imagines a feeding frenzy of investing on “easy” credit and tossing it into all sorts of investments, or perhaps causing bubbles by focusing it in a select few types of investments, with a certain lack of consideration for how sound they may be. But I don’t necessarily understand how that would happen unless the money were free, the differential between market rates and expected returns was so great that caution would be thrown to the wind, or there were other incentives that caused a focus of “malinvestment” into particular investment types. We’re talking about credit, not free money.

Aside from that, I find the way ABCT presents individual actors as being complete morons if short term rates are incomplete as unjustifiably smacking of a cry for a big government investment Gestapo because people simply cannot be trusted to make the appropriate investment choices with credit.

Of course I seem to be the one to find the opposites in synonyms; because surely these people have free markets in mind – Right? If so, then why would they insist market participants are morons who can’t be trusted with credit regardless of the terms. Maybe it isn’t that they can’t be trusted with credit, but they have no way of knowing what will happen in the future, perhaps? Maybe they have no way of knowing when NGDP will be allowed to fall?

There is plenty to question about the modern presentation and application of the theory to issues of today. I will remain skeptical and annoyed with it until these issues can be addressed in a way that is completely understandable and doesn’t accuse of average people of being inherently foolish and untrustworthy. If that were so, free market economies simply would never work even without fractional reserve banking.