... call it "a neglected passage of the General Theory"
Yesterday I offered what I think is a fertile empirical framework for assessing ABCT. This was motivated by thinking from Mario Rizzo on how to get broader acceptance of the Austrian school. One thing I've pointed out before is that the basic dynamics of ABCT are in the General Theory in chapter 16. Of course you wouldn't want to talk about it as a passage from Keynes in actual practice, but you could discuss ABCT as it was outlined by Hayek and then say "even Keynes used some of this logic as a brief aside in his discussion of capital, but he left its implications somewhat underdeveloped".
And underdeveloped it certainly was, but here it is:
"Given the optimum amount of roundaboutness, we shall, of course, select the most efficient roundabout processes which we can find up to the required aggregate. But the optimum amount itself should be such as to provide at the appropriate dates for that part of consumers’ demand which it is desired to defer. In optimum conditions, that is to say, production should be so organised as to produce in the most efficient manner compatible with delivery at the dates at which consumers’ demand is expected to become effective. It is no use to produce for delivery at a different date from this, even though the physical output could be increased by changing the date of delivery; — except in so far as the prospect of a larger meal, so to speak, induces the consumer to anticipate or postpone the hour of dinner. If, after hearing full particulars of the meals he can get by fixing dinner at different hours, the consumer is expected to decide in favour of 8 o'clock, it is the business of the cook to provide the best dinner he can for service at that hour, irrespective of whether 7.30, 8 o'clock or 8.30 is the hour which would suit him best if time counted for nothing, one way or the other, and his only task was to produce the absolutely best dinner. In some phases of society it may be that we could get physically better dinners by dining later than we do; but it is equally conceivable in other phases that we could get better dinners by dining earlier. Our theory must, as I have said above, be applicable to both contingencies.
If the rate of interest were zero, there would be an optimum interval for any given article between the average date of input and the date of consumption, for which labour cost would be a minimum; — a shorter process of production would be less efficient technically, whilst a longer process would also be less efficient by reason of storage costs and deterioration. If, however, the rate of interest exceeds zero, a new element of cost is introduced which increases with the length of the process, so that the optimum interval will be shortened, and the current input to provide for the eventual delivery of the article will have to be curtailed until the prospective price has increased sufficiently to cover the increased cost — a cost which will be increased both by the interest charges and also by the diminished efficiency of the shorter method of production. Whilst if the rate of interest falls below zero (assuming this to be technically possible), the opposite is the case. Given the prospective consumers’ demand, current input to-day has to compete, so to speak, with the alternative of starting input at a later date; and, consequently, current input will only be worth while when the greater cheapness, by reason of greater technical efficiency or prospective price changes, of producing later on rather than now, is insufficient to offset the smaller return from negative interest. In the case of the great majority of articles it would involve great technical inefficiency to start up their input more than a very modest length of time ahead of their prospective consumption. Thus even if the rate of interest is zero, there is a strict limit to the proportion of prospective consumers’ demand which it is profitable to begin providing for in advance; and, as the rate of interest rises, the proportion of the prospective consumers’ demand for which it pays to produce to-day shrinks pari passu."
Malinvestments aren't in there, but the response of the Hayekian triangle to changes in the interest rate is. That ain't bad. So why does Keynes only spend a couple paragraphs on this? Well, he said that the time it takes to produce something is just one facet of its production, and hardly something to build a theory on. He notes that different production processes also smell bad to varying degrees, but we don't have a "smelliness theory". He didn't think it made much sense to pick out one component of economic activity and exalt it as the driver of the system. Keynes stripped the economy down to its essentials: the supply of and demand for goods, and the money used as the intermediary to make that market work. He looked at each of those components and tried to understand how each impacted output. Obviously, I think Keynes took the most fruitful route and Austrians took the less fruitful route. But I don't think the Austrian route is as unfruitful as Keynes suggested. The trade-off between time and interest driving ABCT is a macroeconomic phenomenon - it affects the entire market simultaneously. That makes it a good candidate to explain broad, economy-wide fluctuations. Regardless, the Austrian dynamics are still in Keynes.
So use that! Note that!
If Austrians keep convincing themselves that they hate Keynes and Keynesianism, they're not likely to use that. If Austrians keep telling Keynesians that the Austrian school is incompatible with Keynesianism, the mainstream is going to start to believe it. A better approach, I think, is to say: "Look we've been thinking about it from this angle that hasn't received much attention by the discipline - so we could probably strengthen our understanding of the economy by focusing more on this angle (which, of course, we are well position to provide for you). And although you might no have heard of this stuff before it's not crazy - Keynes laid out the basic dynamics in the General Theory, although he didn't follow through on it. We're here to follow through on it."
Actually, Keynes explicitly rejects Hayek's business cycle theory on the grounds that monetary inflation (an increase in the supply of money) will not distort the structure of production.
ReplyDeleteKeynes writes,
"The notion that the creation of credit by the banking system allows investment to take place to which "no genuine saving" corresponds can only be the result of isolating one of the consequences of the increased bank-credit to the exclusion of the others. If the grant of a bank credit to an entrepreneur additional to the credits already existing allows him to make an addition to current investment which would not have occurred otherwise, incomes will necessarily be increased and at a rate which will normally exceed the rate of increased investment."
Then he writes,
"It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment."
This is from ch. 7 of "The General Theory". Keynes might have believed in the theory of roundaboutness of production, to one degree or another, but Austrian business cycle theory is much more than that.
So, it's not that he doesn't take capital theory to its fullest implications. He rejects these implications based on his theory of money and interest.
I think you're wrong in how your read this. Isn't he just making the point that the savings identity must hold? Would you disagree with that?
ReplyDeleteI'm not saying Keynes gives us ABCT. I'm saying he gives us the response of roundaboutness of production to the interest rate. He doesn't think it's especially important, but he certainly identifies it as a real process.
In a discipline where ABCT is rare, unfamiliar, and (given some of the rhetoric that often comes with it, suspect), I personally think it's pretty important simply that Keynes says "you will see more roundabout production processes as the rate of interest is reduced".
That's pretty cool, isn't it?
What your point about the savings identity is exactly still elludes me I suppose.
"Isn't he just making the point that the savings identity must hold? Would you disagree with that?"
ReplyDeleteWell, the "savings identity" is irrelevant. It has little to do with ABCT (ABCT is not an overinvestment theory). The theory is basically one of price fixing. It applies the uniformity-of-profit principle to intertemporal investment of capital-goods.
Basically, by fixing the price of capital-goods lower than the actual market-price (by reducing the cost of borrowing capital) it therefore distorts the economization of capital-goods. Capital-goods are therefore invested into non-economical lines of production.
Popular representations of ABCT (such as that by Tom Woods) may serve to confuse the reader on what exactly Austrian business cycle theory says. The common representation is that investment is greater than savings, and that is how Keynes interprets it when he writes,
"The notion that the creation of credit by the banking system allows investment to take place to which "no genuine saving" corresponds..."
To be fair, Hayek does put it in these words oftentimes (see: "Prices and Production"), but when you put these words into context it's not a theory of overinvestment. That's why Austrians stress the fact that ABCT is a theory of malinvestment.
Keynes writes,
"If the grant of a bank credit to an entrepreneur additional to the credits already existing allows him to make an addition to current investment which would not have occurred otherwise, incomes will necessarily be increased and at a rate which will normally exceed the rate of increased investment."
Keynes suggests that Austrian intertemporal capital miscoordination cannot take place because credit expansion will necessarily cause wages to rise. He argues that if time preference remains the same, the same proportion of income will be saved, and therefore it's impossible that there be overinvestment.
But, the fact of the matter is that money expansion does not occur simultaneously and proportionally along all lines of production. It does not proportionally occur between the incomes of wage-earners and borrowers. This was one of the insights of Richard Cantillon; inflation will occur first into lines of investment, and then ultimately make its way to wage-earners.
I don't know if Keynes really believed money to be superneutral, but he makes the mistake of believing so at least here (Stiglitz also makes this mistake).
Austrians believe that money borrowed for investment will first effect the prices of higher-order capital-goods. This distorts the price mechanism as a rationing agent, and therefore there is malinvestment.
Austrians do believe that the price mechanism will be restored, which is why they argue that in order to maintain the distortion there needs to be an accelerated creation of money. However, they also believe that once the price mechanism is restored the malinvestment will have to be liquidated, as entrepreneurs realize that those lines of investment are unprofitable (thus, the application of profit and loss).
So, that brings about two major criticisms of Keynes's rejection:
1. Inflation does not occur simultaneously and proportionally amongst all sectors of an economy.
2a. Austrian business cycle theory is not a theory of overinvestment, therefore when Keynes writes, "The notion that the creation of credit by the banking system allows investment to take place to which "no genuine saving" corresponds...", he is not giving an accurate representation of Hayek's theory (and, as I said before, Hayek himself may be one of the causes behind the confusion).
2b. A rise in the income of wage-earners will not cause a rise in real capital-goods. Rather, it will simply restore the price mechanism and reveal the malinvestment which occurred between the time of the initial expansion of credit and the ultimate distribution of new money to wage-earners.
"Well, the "savings identity" is irrelevant."
ReplyDeleteWhat I'm saying is that the section of Keynes you quoted essentially says "the savings identity holds". I agree it's irrelevant to this particular point. So I'm trying to understand why you brought it up.
The rest of your post is hard for me to make sense of. Are you saying that Keynes is talking about ABCT here (what you're quoting)? It doesn't seem to me that he is. He seems to refer to Hayek in an earlier section, not this one. And where he does talk about Hayek he makes the point that Hayek isn't using the terms in the same way that Keynes has been using, which makes your bringing Hayek into the chapter later on especially suspect. I haven't reread the whole chapter but looking over the section here he doesn't seem to comment at all on what has been called the "PQ split" is of this increased investment, so I think it's hard to speculate here on what he's saying about the neutrality of money. Presumably that depends on the state of capacity utilization too, right?
And I'm still not sure what any of this has to do with my post which said you're not going to find ABCT in Keynes - just that you will find enough in it to build a Hayekian triangle.
ReplyDeleteThat seems:
(a.) interesting and noteworthy, and
(b.) important to note if you're going to make your case to more mainstream audiences. Most economists find history of thought interesting and people will especially be interested if you can find anything with the adjective "Hayekian" attached to it in the General Theory.
Daniel,
ReplyDelete"So I'm trying to understand why you brought it up."
Err, because Keynes explicitly uses it to reject Austrian business cycle theory. Are you really this daft?
"Are you saying that Keynes is talking about ABCT here (what you're quoting)? It doesn't seem to me that he is."
Are you serious, Daniel?
Keynes writes,
"The notion that the creation of credit by the banking system allows investment to take place to which "no genuine saving" corresponds can only..."
That is in direct reference to Austrian business cycle theory.
"so I think it's hard to speculate here on what he's saying about the neutrality of money."
I am not speculating. I am commenting on his exact words.
"And I'm still not sure what any of this has to do with my post..."
Because, I obviously think that Austrian theory is incompatible with much of Keynesian theory. It's not about reconciliation. It's about discarding entire portions of Keynesian theory.
In any case, this conversation proves to me that serious, honest, and straightforward debate between us two is impossible. This will be my last post on this blog.
"That is in direct reference to Austrian business cycle theory."
ReplyDeleteCould you show me the reference? He seems to reference it earlier in the chapter only. Read the last sentence of the last paragraph where he mentions Hayek. He closes that conversation pretty decisively. Then he moves on to the relevance of the savings identity for his theory. I don't see where he's talking about ABCT here. Don't keep quoting the same sentence. This is the FOURTH time you've quoted that sentence. What is unclear is not Keynes's position as expressed in that sentence, it is how that position relates to his discussion of ABCT.
Did you get this point from some other publication that I can look at? If you did, maybe I can read that and have a better sense of why you think he's talking about ABCT.
"Because, I obviously think that Austrian theory is incompatible with much of Keynesian theory. It's not about reconciliation. It's about discarding entire portions of Keynesian theory."
ReplyDeleteMy view is that there's nothing about Austrian malinvestment dynamics that breaks down when we think about demand-based theories of output. And there's nothing in demand-based theories that breaks down when you talk about Austrian malinvestment points.
They do work in opposite directions. But that shouldn't be too troubling. The income effect and the substitution effect work in opposite directions too in a standard Slutsky decomposition. We don't get upset over it - we say "the impact is ambiguous", and we leave it open as an empirical question.
That is, I think, ultimately what needs to happen with Keynesian insights and Austrian insights (and insights from a variety of other perspectives, for that matter). Macroeconomists are only at war because they try to think of their theories as "general theories" when they're not, really.
I was going to post:
ReplyDelete"Keynes BAAAAADDDD.
Hayek GOOOOOOD."
... But it seems Jonathan beat me to it.
Just kidding Jonathan; come back!
* For the record, unlike Daniel and the numerous commentators out there, I'm not throwing my lot in with one particular group, Keynesian or otherwise. Primarily, this has to do with my specialising in a particular field of economics (environmental, resource) rather than pure macro or micro. I guess I also like to keep my options open... Lest I be challenged as a pathetic fence-sitter; yes, it does hurt sometimes being perched on one's sensitive bits but the views are great!
My view is that there's nothing about Austrian malinvestment dynamics that breaks down when we think about demand-based theories of output. And there's nothing in demand-based theories that breaks down when you talk about Austrian malinvestment points.
ReplyDeleteI can't make a large comment because I'm pressed for time (as you may have noticed, my comments as of late have dwindled enormously) - but this is incorrect.
The views are mutually incompatible because demand-based theories explicitly reject necessary foundations of Austrian malinvestment theories.
I don't have the time to explain how right now, but I just wanted to clear up the issue (in case you thought otherwise), that Austrians do consider the schools largely incompatible. I'm personally a bit shocked at how much Keynesianism Jonathan endorses. But the reason we have so many disagreements is an issue of fundamentals.
Mattheus - there are fundamentals we disagree on, but I think you have too strong a tendancy to take Austrianism as a whole. So when I say "the two are compatible" and you say "they aren't" we may be talking about two very different things. Maybe I should put it this way - Hayek-Garrison ABCT is reasonably compatible with Keynesianism. Garrison did it himself, after all! He put Keynes into one of his Hayekian triangle models and it worked just fine for him. I would have done it differently, and I've talked about this in the past. I think Garrisons PPF is problematic in how it departs from how we normally think of PPFs. I think he was wrong on how the interest rate reacts to a reduced demand for investment. I think he was wrong to model the interest rate as determined by the loanable funds market, completely leaving out the money market. There are things I would have done very differently to incorporate Keynes, but that was essentially his project.
ReplyDeleteWhen you reject the prospect you (1.) regularly don't provide details - and its not just in this case, but (2.) usually get caught up on a lot of foundational issues around praxeology, etc. I'm just saying that Hayek-Garrison ABCT dynamics work fine with Keynesianism.
I'm a little curious as to how you can endorse a malinvestment theory of depressions when you've told me in the past you don't agree that depressions are a realigning of factors of production to meet true consumer demands.
ReplyDeleteMattheus -
ReplyDeleteWhat do you mean by "endorse a malinvestment theory of depressions"? That may be the source of misunderstanding here.
I'm not claiming I think ABCT alone explains the business cycle. I'm claiming it's a contributor.
If you define ABCT as being "a malinvestment theory of depressions and absolutely no other explanation for depression is valid". Then no, I suppose I don't agree with ABCT. I think it makes more sense t odefine ABCT as "a malinvestment theory of depressions", to which I would say "yes, these ABCT processes are certainly in play and contribute along with a lot of other processes".
The task is to identify the relative importance of the Austrian processes.
The only reason malinvestments are important in an economic perspective are because they highlight how far the "market" has drifted away from providing goods consumers actually demand. This is why Mises talks about the unhampered market so often, because that is the theoretical model by which consumers can acquire exactly what they want. ABCT is important insofar as we recognize this.
ReplyDeleteIf you don't agree that depressions are a necessary realignment, how can you take the lessons ABCT had to say seriously?
I don't do economics for "lessons" - I do it to understand how the economy works from a scientific perspective.
ReplyDeleteABCT introduces an economic process that makes a plausible case as an explanation of depressions. It does not offer any reason to think it provides the sole explanation for depressions.
If it turns out most of the business cycle is derived from Austrian dynamics, then we can talk about your "lessons".
As it stands, for me, the Austrian school is an interesting and potentially important process to keep in mind. My interest right now is understanding how important of a process it is.
I used lessons as a euphemism. Don't get defensive. And you still haven't answered my question.
ReplyDeleteHow can you accept large swathes of ABCT without accepting that depressions are a necessary realignment?
Defensive? I was just clarifying my position, Mattheus.
ReplyDeleteI've answered your question several times now. Let me try again:
ABCT describes a process of readjustment that I accept. ABCT does not provide any reason to think this is the only cause of depressions, but it certainly makes sense as a cause. Something as complicated as an economic downturn presumably has multiple causes.
So, is a depression "necessary"? Well, that depends on what causes it, doesn't it? I see plausible explanations for a depression that could be roughly interpreted as communicating the fact that "depressions are necessary" and I see plausible explanations for depression that could be roughly interpreted as "depressions are unnecessary" or even "depressions are counter-productive".
Whether depressions are necessary or not depends on which cause is most important. That is case specific.
I think our mutual confusion on this point is that you see ABCT as offering something like a singular explanation, whereas I don't.
Think of it this way - lets consider two explanations of depression that are fairly amenable to the Austrian school: regime uncertainty and Hayekian ABCT.
ReplyDeleteWhat do they say about NGDP targeting policies?
Well, NGDP targeting is about as predictable as you can get, right? So regime uncertainty explanations would probably say "that's fine", whereas ABCT explanations would probably say "don't do that".
What you think is more important - regime uncertainty or Hayekian ABCT - is probably going to shape how you feel about NGDP targeting.
But there are certainly Austrians that differ in the emphasis they place on those two processes, aren't there?
I understand your position, but according to Austrians the mechanics of the economy are not open to interpretation or emphasis. It is a logical certainty.
ReplyDeleteWe wouldn't have differences of emphasis on regime uncertainty or ABCT because they are part of the same paradigm. They both create systemic entrepreneurial error which is the cause of the misallocation of capital - ie, malinvestment.
The way I perceive your approach to economics is like that of a botanist. The botanist asks, "What has more impact on the growth of plant life - volume of water or sunlight?" The scientist would then conduct experiments and refer to data to find situations in which one variable had more or less effect than the other.
Austrians can't look at it that way. I find your demand-based explanations not only incorrect from a matter-of-fact view, but misguided by the simple manner in which you approached the question. The methodology of praxeology is inherently intolerant to interpretative answers in the same manner that mathematics and geometry are. The questions Euclidean geometry has to answer are achieved by one avenue and emphasis and interpretation are anathema to it.
Right - that's my understanding of where we differ.
ReplyDeleteBut note you only asked me initially about a "malinvestment theory of depressions". Now you're adding a whole lot of praxeological baggage to that. I don't accept or have too much of an opinion on the praxeology or epistemology of the Austrian school. I'm quite willing to embrace what has become known as the Austrian business cycle theory: the Hayek-Garrison model.
Botanist is fair enough as an explanation - but I think it makes more sense to say that I am a primatologist that specializes in the social organization of one particularly advanced species of primate.
Just because you get your ABCT from praxeology doesn't mean that's the only way to get to a malinvestment theory of depressions.
ReplyDeleteI bet most people who call themselves Austrians don't get ABCT from your approach. Most people who call themselves Austrians derive ABCT from fairly basic neoclassical insights, with a few Hayekian twists.
Technically there is a lot of praxeological baggage for ABCT and the Austrians who do support it do so by arriving at it via praxeology. I've never heard of anyone coming to ABCT without going through mises first, so to speak.
ReplyDeleteObviously I'm glad you're considering the Hayek-Garrison model, and that you do accept the general claim. I'd prefer if you also accepted the preliminary logic by which ABCT was made, but it's true - you don't have to endorse the whole package. You will derive more truth from ABCT if you did more research in the preliminary conclusions beforehand, though.
I didn't strawman your position as an empiricist, did I?
I don't think you did. Where would you have straw manned it? You glossed over some methodology and you left points about deriving theory vague (I'm not entirely with Friedman on theory formation and I'm not an inductionist). So you left some things unstated but nothing struck me as wrong.
ReplyDeleteYou really think you need praxeology?
To take Garrison - does he buy into praxeology? I kind of doubt this - I think you're probably more Misesian than most Austrians and you like to think of Austrianism as Misesian rather than the other way around. I think Austrianism is a bigger umbrella, in other words.
Anyway - none of that is that important that's just my impression.
Okay, just making sure. Unlike my spanish friend here, I'm trying to be less caustic as of late.
ReplyDeleteYou need praxeology to understand why Austrian conclusions are true. If I told someone "low interest rates cause depressions," they could accept that (and any more elaborated story of that - involving Hayek, roundaboutness, etc.) with no preliminary knowledge of praxeology - but they wouldn't know why what I said was true. It would simply sound like an attractive theory.
Garrison uses praxeology. All the top faculty and thinkers in the Austrian school endorse it (perhaps not Reisman). I had face time with over a dozen of them just a few months ago. Praxeology is still very much alive and kicking. As to whether I am a Misesian - yes; but most knowledgeable Austrians would call themselves such. Dr. Garrison (as well as my own dept. chair) would consider himself Hayekian, but that doesn't exclude him at all from accepting and using praxeology. It simply means that he differs on things like monetary disequilibrium or the purpose of government.