I want to quickly share this article in The Economist on the Austrian school. It's a nice, accessible overview. Probably no readers here need anything this basic, but still good to see.
It raises the question of why nobody pays attention to the Austrian school. I think there are two reasons:
1. The version of malinvestments highlighted in the article is not exclusive to the Austrian school at all. I don't know any economist that wouldn't say "credit was cheap, it was poorly invested, and when everyone realized this the market crashed". Now, the arguments for what caused the cheap credit varies... some blame the Fed, some blame the Chinese, some blame the federal government, some blame the market's inability to price credit correctly on its own. There are more Austrian and less Austrian versions of "credit was cheap", but you can get the rest of the story from any school of thought. So why go to the Austrians for the simple point that when money is sloshing around people make bad decisions?
2. Austrians do a good job explaining the boom and bust, but then sort of stop. This is my opinion at least. There's nothing about the distortions or the malinvestments that I fundamentally reject. My concern with the Austrian school has always been that it doesn't recognize the even greater damage that can be done by the demand deficiency induced by a financial crisis that wreaks havoc on balance sheets. Sometimes you get a "secondary deflation" story from Austrians, etc. But you don't get everything that Keynes gives us. I think a lot of people see Austrians engaging in fundamental fallacies when talking about aggregate demand and then are tempted to just plug their ears about the rest that Austrians have to say.
There is good reason for hope on both points! On the first point, even though you don't need the Austrian school at all to explain the dangers of cheap credit, what's unique that the Austrians do provide is insights about the capital structure. In other words, you don't need Austrianism to warn you about cheap credit - but Austrianism will tell you how the danger of cheap credit may manifest itself. That story oughta be told. On the second point, there's reason for hope because as far as I've been able to tell there is no conflict at all between Keynesian aggregate demand dynamics and Austrian business cycle theory (conceived of as the artificial elongation of the capital structure). Many Austrians challenge Keynesian aggregate demand stories but (1.) they're wrong, and (2.) nothing in that challenge is required to make the Austrian capital structure arguments.
So... good article in The Economist, and I maintain my hopes for a synthesis of sorts.
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Many Austrians challenge Keynesian aggregate demand stories but (1.) they're wrong,
ReplyDeleteOh, ok.
(2.) nothing in that challenge is required to make the Austrian capital structure arguments.
Austrian "capital structure arguments" are derived a prioristically via methdological individualism. That route cannot give you aggregate demand stories.
So yes, in a very real sense, the two stories are methdologically imcompatible.
Austrian "capital structure arguments" are derived a prioristically via methdological individualism. That route cannot give you aggregate demand stories.
ReplyDelete1. I see no reason why you can't get aggregate demand stories from a priorism or methodological individualism. Can you explain to me why you can't?
2. Lots of people get to ABCT without a strict reliance on a priorism and methodological individualism. The fact that you get there that way doesn't magically invalidate those that don't get there that way. You're pushing Misesian economics here specifically, not Austrian economics.
Which is precisely why I said "nothing in that challenge is required to make Austrian capital structure arguments" not "nothing in that challenge is ever used to make Austrian capital structure arguments".
ReplyDeleteI am a frequent reader of The Economist, and will probably remain so, but this article reminds me why it is often no better than a tabloid.
ReplyDeleteToo often, it simply gives an oversimplified, quickly rushed perspective that is largely formed of casuitry and general opinion. I am reminded of entire pieces in this magazine which can be summarized into nothing but, "Angela Merkel is a stingy little German woman, because she won't bail out Greece."
Prateek -
ReplyDeleteI think there's some truth to this - particularly the point that they just reflect some sort of "general opinion"/consensus perspective. I'm interested in the example you pick out - I've found that on austerity type questions they take great pains to commit the same sort of attention to each side, precisely because the European audience has so many sympathizers with the German approach.
Don't get me wrong - what you get is still a tailored, simple "consensus" version. You just get the no-frills austerity consensus, and then the equally no-frills non-austerity consensus.
It's not always the deepest analysis, but I do think they do a service by laying everything out so clearly.
I don't really have a background in finance, and this is one area where I really enjoy their simply, straightforward style. Very lucid - very easy to digest, but at the same time not dumbed down.
This piece was probably more dumbed down than most - but then again, business cycle theory is more esoteric than a lot of what they do and their audience is less familiar with the issues. So I think it was inevitable that this piece would be oversimplified. Still, I thought it was quite good.
1. I see no reason why you can't get aggregate demand stories from a priorism or methodological individualism. Can you explain to me why you can't?
ReplyDeleteWhen approaching the catallactic subjects of "supply" and "demand" via methodological individualism, it's helpful to think in terms of thought experiments (for me, anyway). How would you describe the categories of supply and demand in a Crusoe story? Well, you could start talking about the goods that Crusoe makes for himself (flour, water, crab meat, etc). The supply of his goods is determined by the cost it takes to produce them and how intensely he wants to produce them. His supply of firewood is determined by the Marshallian "two scissors" which in this autarkic case are cost of production and use-value. With no one to trade with, no good is assigned any exchange value because it is only he than can use it. All the goods that are produced by Crusoe are goods he plans to definitely use for himself. There is no "supply" or "demand" story to be told, aside from the truism that he supplies all he produces, as well as he demands all that he produces.
Imagine, then, that Friday becomes part of the picture. As an island native, Friday would have different desires than Crusoe in what he chooses to consume. Clearly, if neither Crusoe nor Friday traded, there would be no "story" to tell - it would be a case of two autarkic individuals. But let's suppose they do trade. There is benefit to be had from trade. Comparative advantage is established. Now, supply and demand can be seen as more familiar to our macro conception. All the goods that Friday and Crusoe produce are demanded by either of them. The goods that Crusoe produces are either for himself, or to trade with Friday which will get him other goods he could not produce. The supply of the goods that Crusoe has accumulated for trade will be what he offers in exchange for the goods Friday has made. This payment is demand. In a division of labor between two people, the entire supply of goods produce will either be consumed immediately, or traded and consumed subsequently. There can be no demand over and above what each party has in supply to trade. How could they? The supply they have to trade constitutes their "ability to pay" for the goods the other party makes. Likewise, it is not conceivable to have a supply over and above what each party demands. If there is some supply that is not traded, it is consumed by whoever made it and considered solely for "use-value" that exists in autarkic exchange. It cannot be the case that goods are produced for nobody. If Crusoe constructs 10 spears, and Friday only needs 3, then Crusoe's remaining stock of spears does not vanish. It is an increase in supply as well as an increase in purchasing power. Both what Crusoe has supplied, and therefore what he can demand, have increased. There is no "aggregate demand story" to be told, because all goods that are produced are valued for exchange-value (and ultimately use-value) and this is what gives them increased demand.
This is the complicated version of the dictum that supply creates its own demand. If two trading parties are making only what the other wants (and there is no unsold inventories after the trade), then there cannot be any supply or demand stories. However, if one makes an overabundance (collects far too many berries), this represents an increase in supply for the working party, which will manifest as a greater purchasing power and thus greater demand, which still becomes a wash when you consider aggregate demand. If we consider relative demand, then yes – Crusoe is wealthier than Friday is because he has a greater supply. He can demand more. That much has changed. But the relation between total demand and total supply has not changed because both rise equally. The issue naturally becomes more complicated when we consider malinvestment of goods, etc. but I believe the general condition still holds.
2. Lots of people get to ABCT without a strict reliance on a priorism and methodological individualism. The fact that you get there that way doesn't magically invalidate those that don't get there that way. You're pushing Misesian economics here specifically, not Austrian economics.
ReplyDeleteLots of people get to malinvestment-theory or credit cycle theory without Misesian economics, sure. Arnold Kling talks a lot about recalculation and capital mismatch. Economists of all stripes will acknowledge that "too many houses were built." But they don't arrive at ABCT. You and I think we’re talking about ABCT, but we're really not. ABCT is a logical proof like the Pythagorean theorem. When we talk about ABCT, we're roughly talking about malinvestment theory via credit expansion, but we're not talking about ABCT per se. That requires endorsement of the entire corpus of Austrian economics just like the Pythagorean theorem requires endorsement of the entire corpus of Euclidean geometry and arithmetic.
That requires endorsement of the entire corpus of Austrian economics just like the Pythagorean theorem requires endorsement of the entire corpus of Euclidean geometry and arithmetic.
ReplyDeleteThis is something that you continue to claim without defending at all. I certainly embrace ABCT malinvestment theory without embracing the corpus of Austrian economics. You do not and have not offered a reason to believe that ABCT must come with other elements of Austrian theory. I think you really oughta call what you're talking about "Misesian ABCT" or something like that. You're trying to sneak praxeology and methodological individualism in the back door without doing the actual work of demonstrating why it of necessity belongs there.
I agree with the classic Crusoe economy example as far as it goes, but there are two simplifications provided in this economy that are traditionally remarked on: (1.) autarky, which you note and relax, and (2.) a barter economy, which you leave out.
ReplyDeleteIt's precisely the introduction of money that introduces all the AD problems, so it's really not surprising that we don't come to AD problems in your example.
I think you really oughta call what you're talking about "Misesian ABCT" or something like that.
ReplyDeleteJust like the 6th grade teacher ought to call her class "Euclidean geometry" instead of plain old geometry?
The fact is, ABCT is Misesian ABCT. It's called AUSTRIAN BUSINESS CYCLE THEORY. Not malinvestment theory. Not credit cycle theory. Not even fiduciary media theory.
You might endorse a type of malinvestment theory 80 or 90% congruent with ABCT (you understand the effects of low interest rates caused by fiduciary media and how that leads to a boom in higher order goods, etc.) - but you don't understand ABCT. It is a VERY specific logical proof.
Don't get me wrong - I'm glad you and I are on the same boat with regards to low interest rates and malinvestment, etc. But there are huge amounts of material on capital theory, implications of action, monetary theory, that you don't necessarily get from "malinvestment theory" that are necessary for ABCT.
It's precisely the introduction of money that introduces all the AD problems, so it's really not surprising that we don't come to AD problems in your example.
I can write another comment (or better yet a whole post), finishing the economy of Crusoe and Friday as they arrive back in England, start using money, etc. without having any AD problems. It's not a part I left out deliberately.
No Mattheus, not just like that. You can't have 6th grade geometry without Euclid. You can have ABCT without Mises. It's a fairly blatant false equivalence.
ReplyDeleteAlthough there would be nothing wrong with calling it Euclidean Geometry. Indeed, once students are made aware there is more than just Euclid you do refer to it as "Euclidean Geometry".
"I can write another comment (or better yet a whole post), finishing the economy of Crusoe and Friday as they arrive back in England, start using money, etc. without having any AD problems. It's not a part I left out deliberately."
ReplyDeleteAnd that is where I'm sure we'll start to disagree and I'll point out that you do have AD problems. Don't feel obligated to write anything up. I'm just noting why your example thus far doesn't shake me that much.
To be specific, the recession is an AD problem. Austrians wouldn't argue that it was caused by AD problems, but a fall in AD is the result. Where Austrians and Keynesians differ is on how to restore AD to AS (that is, how to "fully" use all available economic goods).
ReplyDeleteAustrian methodology isn't necessary for broadly understanding or agreeing with these points. What Austrian methodology is useful for, however, is developing the way you think so that you consider all factors which relate (that is, monetary factors, capital factors, unemployment factors, et cetera). It's really a focus on causality and logical rigor, and praxeology is the extreme (more accurate) version of it.
Methodology is also relevant on how you develop theory thereafter.
You can have ABCT without Mises.
ReplyDeleteSuch a strong statement coming from the economist who is admittedly refuses to read anything substantial from Mises.
ABCT is a logical proof with substantial contributions by Mises. It's called the Mises-Hayek theory of the business cycle to some, but Mises already had a credit cycle theory derived from The Theory of Money and Credit in 1912. It wasn't as well polished until Hayek's Prices and Production, granted. But the major contributions came from Mises himself. I can't think of an Austrian economist that would have a serious problem if it were referred to as "Misesian Business Cycle Theory."
So no, Daniel. You can't have ABCT without Mises. You can have malinvestment theories that talk about credit expansion and capital goods - but you can't logically have ABCT without Ludwig von Mises.
And that is where I'm sure we'll start to disagree and I'll point out that you do have AD problems.
The contributions by Menger on the origins of money and indirect exchange would say a lot on this. Following the Mengerian theories on money, it makes as much sense to have AD problems in indirect exchange as it does direct exchange - which is to say, none at all.
Just another Austrian theory that is incompatible with Keynesianism.