Dr Horwitz’s thoughtful and generous response to my original post is useful in clarifying what a serious Austrian school economist thinks and correcting some of my misapprehensions. It seems to have been a useful exercise, to provide reactions to Austrian commentary from someone much more familiar with mainstream economics. Even better, I now have something I can point to correct what Dr Horwitz rather nicely calls “consumer Austrians”.
Dr Horwitz has also provided useful links, such as Peter Lewin’s Capital in Disequilibrium. Though not always useful in the sense of being persuasive. I have never been comfortable with the Austrian framing of action in terms of plans by economic agents, in part because it smacks of responding to socialist touting of plans, a sort of high modernist hangover. Reading Peter Lewin’s book has crystallised the rest of my discomfort. Speaking as someone in business, the notion of a specific plan is not how one thinks of capital goods. It is about creating a capacity to produce that will (hopefully) pay its way across the flux of commercial circumstances. You do not have a definitive plan, you have an intent and associated estimations and you manage use of the capital goods as you go.
To invest in capital good(s) is to purchase capacity, capacity that typically expands production possibilities. Production possibilities that are not likely to be fully predictable, as some may only reveal themselves in use or once the capacity is there. One does notpurchase a production path (except in retrospect) for that is revealed over time. The hope is that the manifested production path is not, overall, below break even for the cost of the capital good. Having a plan, in the sense of pre-specified actions, is typically a way to retard performance through failing to respond quickly and effectively to new information and possibilities.
If the above is included in what is intended to be covered by the term ‘plan’, then it is highly misleading terminology and should be abandoned for something clearer.
It remains of concern, the way folk who regard themselves as followers of the Austrian school are so frequently so arrogant and abusive (and, according to Dr Horwitz, often don’t understand the school of analysis they are so attached to). They are so, fairly clearly, because they believe they are possessors of “self-evident” truths about matters economic which follow from the inner logic of economic life. Since it is not a matter of competing empirical claims, but of intrinsic logic which has already laid bare by the Austrian school, they are left with only malice and stupidity to explain differences of economic opinion.
This embrace of a self-righteous “self-evident” rationalism is exacerbated by the moral commitments that the Austrian school comes with. Harold Demsetz’s rather grumpy response (pdf) to an attack by Walter Block on himself and Ronald Coase provides an nice example of economists discussing the positive economics and being subject to a moralising attack from an indignant Austrian.
So consumer Austrians (to use Steve Horwitz’s term) act like Eric Hoffer True Believers. No evidence or argument pierces their armour of self-righteous certitude. There is an Austrian form of political correctnes–political correctness as defined by Matt Ridleyof ought implying is–whereby economic phenomena are treated as if they are the way they ought to be for Austrian analysis to be correct and for Austrian normative preferences to be optimal policy. I vividly remember listening to a young Austrian economist tell his audience that “by definition” what government did could not be investment.
There is also a recurring failure to acknowledge that von Mises and Hayek got the 1930s Depression very seriously wrong (regarding appropriate policy response), as Hayek later admitted. With the result that their would-be acolytes are getting the Great Recession wrong, for essentially the same reasons. It is extremely poor advertising for the virtues of Austrian analysis if it attracts such unfortunate outlooks and behaviour.
On the other hand, as noted above, Dr Horwitz’s comments will be a useful rejoinder to such. (Who, as Dr Horwitz implies, much of my original comments were directed to.)
Of course, the “Austerians” (the Austrian supporters of austerity), as they [and other supporters of austerity] have come to be called, are not the only ones recycling past mistakes. If one reads either version of the paper (pdf) by Barry Eichengreen and Peter Temin, The Gold standard and the Great Depression, and replaces gold standard with inflation targeting, one gets an almost perfect description of the current failures of central banks and the mentality behind such; of the current mentality of the US Federal Reserve (the Fed), the European Central Bank (ECB), the Bank of England (BoE) and the Bank of Japan (BoJ). Particularly when the Eichengreen and Temin say (p.19 of the NBER paper):
policies were perverse because they were designed to preserve the gold standard, not employment.
Replace gold standard with inflation target and that is exactly what has been happening in our own time. Indeed, it was worse than that as the Fed and the Bank of France were not even “doing” the gold standard properly (pdf). Just as the ECB and the Fed are now not even doing inflation targeting properly. In all these cases, the central banks are and were being too restrictive. They acted and are acting, in effect, like conventional monopolists; underproviding their product in order to maximise return–the return being the “sound money” reputation of the officials involved and, after disaster unfolded, in refusing to change course, seeking protection from explicit or implicit responsibility for economic disaster.
Which brings me to my first specific disagreement with Dr Horwitz, his claim that:
Austrians emphasize inflation more because it has been and will be far more the real-world problem in a world of government central banks that have a strong incentive to err in the direction of inflation as a way to reduce the burden of government debt and raise revenue. After all, historically, that’s where central banks came from: governments created them when they could not raise revenue, especially for wars, through other means such as taxation or bond issues. … in theory inflation and deflation are “equally” important phenomena, and my book argues that case, but in practice? Not so much.
As I noted earlier, there are very strong theoretical and historical reasons to do so as an empirical matter. Central banks were born in the crucible of inflation – it is their raison d’etre. They do make systematic errors in that direction because virtually every incentive they face is to do so… Yes, deflation can cause real problems and can’t be ignored (I’ve taken heat from other Austrians for paying too much attention to deflation), but Austrians are living in the real world more than Lorenzo by recognizing the historical fact that central banks are almost always inflators, not deflators. Their mistakes are not random; they are in fact systematic because the incentives are there to make one type of error and not the other.
Actually, central banks were born in debt management. This could be, but was not always, inflationary during wartime. Under some circumstances there is an inflationary incentive, but since the history of central banks dates back to the late C17th (central banking dates back to the founding of the Sveriges Riksbank in 1664, and the founding of the Bank of England in 1694), we can see this is not always the case. (The Bank of England, in particular, presided over long periods of stable, or at least non-inflationary, prices.) We should have no presumption about the direction of central bank failure; indeed, it is precisely such a presumption which during the 1930s did and is now doing its destructive bit to help central banks avoid accountability for their grotesque refusal to take responsibility for ensuring that there is sufficient money, and associated expectations, to keep the level of transactions on a stable path.
It is also revealing that Horwitz finds himself criticised from fellow Austrians for taking deflation “too” seriously. Presumably, taking unexpected disinflation seriously would be even more problematic, yet it clearly had much to do with current problems.
Regarding Dr Horwitz’s question:
But that does not exclude the possibility that the 20s involved an inflationary boom that produced the original downturn in August of 1929 (which precedes the stock market crash of course). … Austrians are interested (though not exclusively) in explaining why the turning point happens in the first place. The typical Austrian business cycle story is sufficient, but not necessary, cause of a bust. But saying that other factors were in play, such as in the Great Depression, does not, by itself, exclude the possibility that the origins (though not depth and length) of the bust are to be found in prior inflationary boom. Let’s go look and find out!
As Dr Horwitz implies, the 1929 Crash is not very interesting. No more so than the 1987 Crash, which was of comparable size but without associated economic disaster. Said economic disaster having almost nothing to do with the 1929 Crash and everything with the (massively deflationary) policies of central banks. (On the matter of timing of the downturn, I would give some weight to the actions of the Bank of France [pdf], rather than just the Fed’s.) Hence the importance of not having a presumption about the direction of central bank failure. The two great central-bank-induced failures of the last 100 years have both come from central banks being far too restrictive, far too concerned about monetary value credibility. The damage from these two episodes have vastly exceeded the harm from periods of inflationary bias. Particularly when one adds in the effects of deflationary policies in Italy after World War One and the “strong money” policies in interwar Britain during the 1920s.
Giving too much credit
As he suggested, Dr Horwitz’s essay on Say’s Law from an Austrian perspective is well worth reading. Alas, I had the normal reaction I do when reading Austrian analysis; I am nodding along with the comments on information and markets as discovery mechanisms (particularly obvious when your business really does not have any identical product to compare prices with) and then we come to the analysis of the business cycle and I find myself suddenly very underwhelmed. (Especially with the apparent implication that inflationary central banks are required for the business cycle to occur.)
Yes, we have this clear picture presented and then one asks, but what is the evidence for this? It is a nice story, but why should we treat it as other than, at best, one way economies can run into difficulties? Australian experience over the last two decades makes the Austrian business cycle analysis much less plausible. The Reserve Bank of Australia (RBA) has been running a policy mildly more inflationary than the Fed, ECB and BoE, and significantly so than the BoJ, yet has avoided the recessions that have bedeviled all the aforementioned economies.
The Austrian business cycle story is both a production cycle and an asset price story. The asset market I am most familiar with, the housing market, simply does not conform to the postulated pattern. This is very obvious in recent US economic history, where different housing markets have had very different patterns under the same monetary policy. (Which is one of the reasons I do not accept Dr Horwitz’s analysis of [pdf] the Great Recession, or his suggested policy response.)
When one examines the operation of housing markets, it is very clear that it is supply constraints that are by far the most important driver in (housing land) prices. That the bidding up of prices due to supply constraints then encourages further such bidding because of housing land’s apparent revealed excellence as a store of value.
Why could this not be a more general pattern–that the boom runs into supply constraints that leads to overshooting of factor and asset prices? A result of the response of output to demand being “lumpy” due to capital and production processes being heterogeneous resulting in uneven expansions of capacity. Prices then fall as orders bottlekneck, creating a negative income expectations and wealth shock which leads to an increased demand for money which, if not compensated for by an increased supply of money, leads to a transactions crash (i.e. a “bust”/recession/depression); in a monetary exchange economy, recessions being always and everywhere a monetary phenomena.
A pattern that is entirely “natural” and is not based on some weird blindness of entrepreneurs to government policy whereby they get repeatedly fooled by government manipulation of interest rates (the Austrian story) and engage in remarkably overconfidentindefinite projection of interest rates. (As Peter Lewin notes, there is no particular reason to think that entrepreneurs will not “see through” the inflationary nature of such policies.)
The RBA has managed, since 1991, to keep the Australian economy from sliding into recession precisely because it has tightened monetary policy when things are running “hot” and loosened them when they are running “cold”. A business cycle pattern which has little or nothing to do with credit inflation, and which has effectively been managed into mildness by an active central bank running a mildly more inflationary policy than other major Western countries, really is not a good place from which to find the Austrian analysis of business cycles plausible.
Note, I am not saying the above is the only way a boom-bust cycle could occur (any appropriate demand or supply shock which led to an increased demand for money not matched by increased supply could have the same effect), I am merely pointing out that it is an entirely plausible way such a cycle could occur where the basic fluctuation is “natural” to the economic system, particularly in an economy with technological innovation. One that is much more plausible than the Austrian “stupid entrepreneurs” and “it takes an inflationary central bank” theory of the business cycle.
If we reject the Hayekian notion of uncertainty as simply being dispersal of knowledge (which market prices can fully deal with, if allowed to) and accept the Knight-Keynes-Schumpeter approach that uncertainty represents the reality that some knowledge is simply missing (starting with there being no information from the future), then there are further grounds to accept some natural economic instability; even more so with technological innovation (pdf). But even in more technologically stable markets, the inability to know when turning points will occur (no information from the future)–such as the inability to know when the self-fueling apparent revelation of housing land as a superior store of value will collapse–creates overshooting and price collapses.
I am also curious why, on the Austrian story, wouldn’t people be really fooled when interest rates are near-zero? “Great, I can invest all I want at almost no time cost!” In reality, to entrepreneurs, interest rates are only a cost whose likely future path has to be considered; the income expectations arising out of the current commercial circumstances also matter. That this is so is particularly clear in present circumstances, when the monetary base in the US and Japan is very high, interest rates are very low, yet folk are not investing all that much precisely because their income expectations are so poor. (In Australia, the monetary base is much lower, interest rates are higher, and investment and economic activity is doing rather better, thank you very much, because income expectations are much stronger.) That, in monetary matters, quantities do not speak for themselves is something Austrian analysis should be comfortable with; that prices also do not speak for themselves, perhaps not quite so much.
As noted above, particularly due to my knowledge of the heterogeneity of housing markets, I did not find Dr Horwitz’s analysis (pdf) of the Great Recession and appropriate policy response plausible. It seemed to be a case of “there is a standard Austrian story to be told and it is going to be told yet again, damnit”. I much prefer Clark Johnson’s analysis (pdf).
But Dr Horwitz’s analysis is a nicely clear statement of the Austrian business cycle theory, and associated concepts. The Austrian story assumes even flow in access to resources (i.e. no fluctuating capacity constraints), no macro-shifts in consumer time preferences and appears to gloss over the role of risk and uncertainty (and shifts in level and framing of same) in time preferences. Accepting the reality of all of them would, of course, undermine blaming the business cycle on inflating central banks.
I was particularly unimpressed with the following:
That the capital goods industries expanded during booms and contracted during busts was an empirical observation that demanded explanation in any theory of the cycle
This struck me as an unremarkable, even trivial, observation. Of course production of capital goods expand disproportionately in booms and contract disproportionately in busts, capital goods have much longer transaction horizons than consumer goods. Their value is fundamentally based on expectations about their role as a continuing source of income. So they will be far more sensitive to shifts in expectations than consumer goods. All the above observation tells us is that capital goods, as assets, have expectations-based value and that there is a business cycle (i.e. commercial activity, and the expectations derived therefrom, goes up and down).
As for the housing and financial market problems that led to the Global Financial Crisis, the destruction of prudence, and the unstable effects of innovation (these being magnified by the destruction of prudence encouraging perverse innovation), were much more important than monetary policy in causing problems in finance markets. The “micro” features of finance and housing markets were more important than the macro effects of monetary policy. Where monetary policy really mattered was in the aftermath, with the failure to respond to the increased demand for money.
Dr Horwitz also re-runs the standard Austrian attack on treating capital as an aggregate:
Because capital is, for the Austrians, always embodied in specific goods, it cannot be treated as an undifferentiated mass. Entrepreneurs purchase inputs or build machines that are designed for specific purposes. They cannot be costlessly redeployed to an infinite number of other uses the way the homogenous conception of capital might suggest.
Well, yes, up to a point. For aggregation is necessary for action over any scale; a corporation aggregates, a state aggregates. Yes, nuances are lost but this does not disqualify such abstraction. A capital-rich society is very different from a capital-poor one. One where labour income depends on the labour/land ratio is very different from one where it depends on the capital/labour ratio. And there are useful things to say about such differences.
Only congenial complexity
While I agree with Dr Horwitz that markets are generally superior allocation mechanisms, the optimum private/public border can be a complex question. The-market-as-superior-allocation-mechanism can slide very easily into an unfortunately simplistic market fundamentalism. I take Dr Horwitz’s point about Austrian rejection of standard equilibrium analysis, but there is in Austrian economics a deep confidence in the coordinating function of markets, particularly prices, that easily becomes dangerously dismissive of the possibility and, in the circumstances of now and the 1930s, the reality of coordination being restricted to very sub-optimal outcomes by, in the context of sticky wages and prices, income expectations continuing to be repressed due to money and associated expectations being underprovided. That, as Dr Horwitz notes, prices can be in error does not, of itself, undermine this confidence–that is just part of markets-as-discovery processes. The issue is more if errors in prices are systematic or not (and, if so, why).
Dr Horwitz tells us that Austrian analysis has moved on, but the Mises/Hayek position in the 1930s was clearly that price adjustments could and should do the job of bringing back full employment: this was clearly false given the realities of modern economies. Moreover, taking any position categorically on which is worse, inflation or unemployment, is vile nonsense. It entirely depends on what the economic situation is at the time. Now, as in the 1930s, unemployment was and is much the worse problem.
Accompanying the deep confidence in coordination by market prices is an exaggerated belief in the necessity of untarnished monetary calculation for economic functioning. This feeds into the inflation obsession, though it shouldn’t as deflation disrupts monetary calculation every bit as much as inflation and deflation’s effect on the willingness to transact is generally more negative–folk being less willing to spend money rising in value than money falling in value; particularly if falling money income is making existing debt and other obligations more onerous. But this exaggerated belief also led Mises and Hayek to wildly overstate the rate of operation of calculation difficulties in a centrally planned state. Not only is the human capacity to “muddle through” greater than they supposed (such as Leninist central planners using Western newspaper prices and mail-order catalogues in the planning process), but other calculation criteria can be used (however less satisfactory for handling complexity). Our hominid ancestors managed to engage in successful productive activity (of a limited scale, but of a life-or-death nature) for millions of years before anyone got around to inventing money.
The Austrian School predilection for Just So stories reaches deep into the heart of Austrian economics, notably Menger and Mises‘ approach to the origins and value of money, as usefully set out by Bob Murphy, with its nonsense history of human societies starting with barter (“this piece of meat for those two yams” spot trades, which is not remotely how foraging groups operate) and spontaneously converging media of exchange. (But that is the subject of a forthcoming post, a companion piece to my Easy Guide to Monetary Policy, so I will leave the matter for now.)
Mark Lewin, in his Capital in Disequilibrium, gives us another such Just So story:
For example, we share categories for measuring space—distance (miles and kilometers), area (acres of land), and volume (gallons of gasoline)—and weight (pounds of sugar), figuring accounts, classifying occupations, driving on the roads, walking along pathways, and innumerable other conventions, customs, habits, and the like, which make our actions predictable to others. These institutionalized categories and modes of behavior (which we may designate as institutions broadly understood) are the cumulative unintended results of individual actions and they represent a real convergence of expectations. Starting out from a position of many different standards or modes of behavior that converge to one or a few implies that individuals come to expect certain kinds of behavior, with a degree of confidence related to degree of conformity of the particular standard.
This is nonsense history, as James C. Scott’s Seeing Like A State sets out very nicely. The development of standardised units of measurement did not arise spontaneously, but was a process imposed on social diversity by states that homogenise and rationalise so they can “see” and so tax and control (building on a pattern going back to the origins of the state). Austrian analysis is so impressed with spontaneous order, it falsely projects it onto patterns of historical evolution.
Nicholas Wapshot’s Keynes/Hayek: the Clash that Defined Modern Economics is an enlightening book, but it reinforces the view that I came to after reading David Glasner’s posts explaining the prescience of Gustav Cassel and R. G. Hawtrey (discussed in more detail here [pdf]); that, admitting their real contributions, much damage was also done to the development of economics by the brilliance of Keynes and Hayek, for both were significantly wrong. Hayek was wrong on the business cycle, appropriate responses to a severe downturn (particularly his obsession about inflationary dangers–there are worse things than mild inflation; it was not inflationary policies that helped bring Mussolini and Hitler to power but deflationary ones) and the nature of uncertainty. Keynes encouraged a false downplaying of monetary policies and overestimated the likely efficacy of fiscal stimulus and underestimated its likely costs. In particular, fiscal stimulus is a political mechanism and cannot be separated–particularly not as a general prescription–from the limitations of political mechanisms. (Perhaps because it is about Keynes and Hayek, Wapshot’s coverage of monetary history and policy is patchy; much better on the 1920s and the lead-up to Bretton Woods, when Keynes was focused on them, than later.)
Reading Wapshot and other writers on interwar economic history, it is also clear how much damage to Britain’s capacities, social cohesion and self-confidence was done by “strong money” policies; with disastrous results at home and internationally. Policy makers (though not Keynes) failed to note how the economy had changed in structure or replicate the commercially-grounded pragmatism of past policy.
A recurring theme in Wapshot’s book is the barrier to the persuasiveness of Austrian economics due to its very specific terminology. If Austrian economics is going to be persuasive, it needs to be accessible. If it uses public language with private meanings, then it will be misunderstood (even, apparently, by people who are self-declared adherents). It is all very well to say that, if you do the reading, you can understand what is really meant, but why should people bother to do that reading? And how much is it legitimate to complain about people reading words and terms in familiar ways?
Austrian economics concerns itself with issues of importance that interest me–some of them greatly–and it does so from a moral perspective I have considerable sympathy for. Yet I continue to find myself unpersuaded that I should expend much time and effort exploring Austrian economics further. Especially given the way so many self-proclaimed followers of Austrian economics are exactly, and perniciously, repeating the role of Austrian school commentary in the 1930s; burbling on about entirely imaginary (in the then and now circumstances) inflationary dangers, so banging the drum for disastrous monetary policies. I fear Bryan Caplan is basically correct (though, despite my comments above, I would give the economic calculation critique of socialism more credit than he does); what Austrian economics has to say about economics that is of value, mainstream economics either has or can incorporate and what it has to say that is not such is either not very useful or simply wrong.
[Cross-posted at Critical Thinking Applied.]