Monday, April 5, 2010

Intellectual Arbitrage: A Keynesian-Austrian Synthesis?

"Arbitrage" describes a situation where someone takes advantage of a price differential to make a profit. For example, if the same TV were selling in New York City for $200 and in Chicago for $250, and the cost per TV of transporting them between the two cities was only $10, someone could buy TVs in New York for $200, sell them in Chicago for $250, and make a $40 profit. They'd be crazy not to keep selling them this way until the price differential was eliminated. The logic of arbitrage drives the so called "law of one price" in economics and the assumption that economic profits (as opposed to accounting profits, which are somewhat different) are always driven to zero by market forces.

The concept of arbitrage is useful more broadly, of course. It's applicable in any situation where a previously unexploited differential furnishes the opportunity for considerable gain. All this is simply an introduction to a very brief thought I had this morning on a potential intellectual synthesis. Some of the greatest advances in science - particularly social science, where competing theories are more likely to coexist than in natural science - occur as a result of the synthesis of two previously competing ideas. The history of philosophy is full of such syntheses as well.

This morning, checking my blog roll, I stumbled across a post that reconfirmed earlier thoughts I've had about the prospect for a Keynesian-Austrian synthesis while listening to a Roger Garrison lecture. At the Coordination Problem blog, Peter Boettke of George Mason University wrote this of a new Hayek resource online:

"It is well worth looking through the entire site and the reading list for both economics and politics. Friedman has been pushing for the epistemic turn in economics and politics since the founding of Critical Review in the 1980s, and during that time Jeff's work with the journal has gotten major intellectual recognition twice -- during the political science perestroika dispute over rational choice theory, and during the last year over the financial crisis. In both instances, the same Hayekian insight into human ignorance was a central element in his explanation for how we need to reorient economics and politics."

If you took out "Hayekian" in that last sentence, I could have sworn this post was by Prof. Skidelsky talking about the Keynesian revolution. Human ignorance and uncertainty drives both the Keynesian system and the Austrian system, albeit in somewhat different ways. There really is considerable common ground between Keynesians and the Austrian School of economics. There are gaping chasms separating the two, as well, believe me. For all that I enjoy reading the Austrians, there is no way I could ever attend a school like George Mason. They're epistemologically out of their gourds, there are some insights I consider completely wrong, and they're a very ideological bunch generally. But there are pearls of wisdom in the Austrian School and considerable common ground that gets ignored, I think, because of their other eccentricities.
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As I alluded to, I had this reaction before listening to Garrison's macroeconomics. I think of it whenever I hear an Austrian badmouth Joe Stiglitz, because I've always thought that the work that Stiglitz won the Nobel Prize for and the work that Hayek won his Nobel for are on a very similar wavelength. The hostility just seems so wasteful to me. I had this gut reaction about the potential for intellectual arbitrage a couple months ago when Boettke renamed his blog "Coordination Problem" in the first place (I can't find the initial name... I think it was simply "Austrian Economics Blog"). I did a double take when they announced that name because so called "coordination problems" are so central to Keynesian microfoundations. Why in the world would an Austrian blog take that name? Apparently, because they think in those terms too. I was first introduced to the idea of emergent order and a self-organizing economy by uber-Keynesian Paul Krugman's book on the subject. It was only years later that I even learned that the Austrian School cares deeply about those issues as well. Cafe Hayek's subtitle references the concept of "emergence" and they regularly post on the idea. Who knew? Similarly, the phenomenon I've always called "unintended consequences" or simply "counterfactuals" is the same as a concept that the Austrians feel like they own under the moniker "seen and unseen" (from a famous Fredric Bastiat piece).

Of course not everything will be reconciled, but I think there's a huge potential for arbitrage between the Austrian School of economics and Keynesian economics that is not being exploited. Keynesians barely pay attention to the Austrian School, because for the most part they're unaware of its existence. They feel that they have bigger fish to fry (and as a practical matter, they probably do). Austrians are very aware of the existence of Keynesians, but they're absolutely committed to the idea of some mortal-foe death match between the two camps. Since Keynesians generally don't bother engaging Austrians, the Austrians have a habit of imputing ideas to Kenyesians. Of course this isn't intellectually productive at all. The highly ideologically-tinged atmosphere of the Austrian School also tends to degenerate into accusing Keynesians of being socialists. And once you're branded a socialist, the opportunity for constructive dialogue is reduced considerably as well. Readers of this blog know I think there's a lot wrong with the Austrians, and I do enjoy mocking their eccentricities. But I keep coming back to them because it's a very interesting and very different perspective that I do think has a few things to offer.

I have a few very specific ideas for how one might go about synthesizing Keynesianism and the Austrian School that I'll probably try to write up at some point over the next year. I was curious if readers knew of any previous attempts at such a project. I know John Hicks had a healthy dose of respect for the Austrians, and both Keynesians and Austrians admire Wicksell - but I'm not really aware of any previous attempt besides that. I know some history of thought people and several Austrians regularly check in on this blog, so I'm counting on you - do you know of any examples?


UPDATE: Steve Horwitz makes an important point in the comment section of Coordination Problem. It is wrong to say (as I also did above) that Hayek got the Nobel prize for his work on knowledge and information. He got the price for his work on macroeconomics and social institutions. It was the prize lecture that was the opening salvo in Hayek's valuable work on knowledge.

44 comments:

  1. Paul Krugman wrote,

    “My view is that the fatal flaw in Austrian economics is that it can’t explain unemployment — or, worse, that it thinks that it can explain unemployment, but is deluding itself. The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.”
    Here is an “Austrian” explanation of unemployment that Prof. Krugman has overlooked.

    “The bust by itself would not cause unemployment. That is a consequence of policies preceding the downturn, such as minimum wage laws. In a downturn without such policies, some capitalists would lose their investments but their displaced workers would just move on to other lower paying jobs.

    Then why does unemployment appear especially during a downturn?

    While, for example, a minimum wage law, by itself, raised wages above market clearing, full employment levels, inflation could bring real wage rates back down to those levels.

    “If in the course of…inflation the rise in wage rates lags behind the rise in the prices of commodities, institutional unemployment may shrink or disappear altogether. But what makes it shrink or disappear is precisely the fact that such an outcome is tantamount to a drop in real wage rates.” Mises

    And, just as inflation brought real wages back down to market clearing, full employment levels, deflation would, in effect, drive them back up again, to unemployment levels.

    So, while inflation masked the unemployment effect of the preceding interventionist policy, deflation exposed it.

    But that wasn’t the same as causing it. It was still the preceding policies and not the deflation itself that was the underlying cause.

    See http://econotrashtalk.org/#The_Cause_and_Cure_of_the_Depression

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  2. Welcome to the blog, DG Lesvic - Arnold Kling addressed this point by Krugman recently too. I think Krugman unfairly attributes this one to "Austrians" in general, when as far as I can tell it's just Kling's recalculation theory. In the past, Kling has mentioned a couple other people that share that view with him - but I've never gotten the impression it's an "Austrian" view per se.

    In the interest of a synthesis (and of course this is a very superficial one) - note that there's nothing that Mises said there that is inconsistent with a Keynesian view of the matter :)

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  3. "It was the prize lecture that was the opening salvo in Hayek's valuable work on knowledge."

    If you say that this was his first contribution in that line of thought, you are very wrong.

    Hayek wrote about knowledge since 1933, as far as I know. His best known essays on the subject were written in 1937 and 1945. Also in 1952 he had an entire book published, also a collection of essays published in the '40s.

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  4. "If you say that this was his first contribution in that line of thought, you are very wrong."

    No, I honestly was not trying to present some comprehensive Hayek bibliography. I should not have said "opening salvo". It has arguably been the best known statement on the issue. My apologies for the confusion - my intention was more just to highlight Horwitz's point that he didn't get the Nobel for that work.

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  5. No, it is not his best known statement, it is just the one you know bout :).

    There was a time when people used to learn about something and then talk about it. Sadly, a lost tradition.

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  6. I'd say it's probably tied with the Uses of Knowledge in Society. It may not be his best. It may be a travesty that it's among his best known. But it is his best known on the subject.

    If you take a sampling of the works of Hayek that people in general are aware of (if they're aware of any), they're going to mention Road to Serfdom, Fatal Conceit, and Pretense of Knowledge - perhaps Uses of Knowledge in Society too, as I said earlier.

    You opine that people should learn about something and then talk about. Sure - now tell me where you "learned about" what his best known works are. Is there a survey available on that question? If you actually took Hayek's thoughts on knowledge to heart rather than using them as something to bludgeon people over the head with, you'd recognize that an issue such as "Hayek's best known works" is a fairly vague question requiring the coordination of a great deal of decentralized knowledge. It's not a question taht lends itself to pointless anonymous lectures when you have no objective way of knowing what is more broadly read of his than I do. That's why I said it's "arguably" his best known work on the subject - because these sorts of things are general impressions, and don't require blog comment area brow-beating.

    If you're just going to nit-pick on non-substantive issues (particularly if you're going to do it anonymously), I'd appreciate you not commenting on the blog. If you're going to nit-pick on substantive issues, feel free to.

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  7. I didn’t want to offend you. And I certainly didn’t want to present some comprehensive bibliography of Hayek. I just thought that someone else would read that statement as I did, so I wanted to correct it and point out that the knowledge problem was a long term affair for Hayek.

    As a token of peace, here are two interviews of Garrison on the possibility of a synthesis. The first one is more on the mark. Also I would recommend Garrison’s book, "Time and Money."

    http://www.auburn.edu/~garriro/a1interview.htm
    http://www.auburn.edu/~garriro/aenrg.htm

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  8. Garrison is the one I'm most interested in in this regard. Specifically, it seems to me that he can very easily be integrated into a Modigiliani-type IS-LM model. I'm sure we could get some interesting insights from bringing liquidity preference and Garrison's views on capital structure together. Thanks for the links.

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  9. Daniel,

    First, permit me to restate my thesis, a little better, I hope.

    Prof. Krugman thinks that he has found a fatal flaw in the Austrian Theory of the Business Cycle, that it can’t explain unemployment.

    "The Austrian view is that...workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods...But this immediately raises the question, why isn't there similar unemployment during the boom, as workers are transferred into investment goods production?"

    Here, at least, is one “Austrian” answer.

    The bust by itself would not cause unemployment. That is a consequence of policies preceding the downturn, such as minimum wage laws. In a downturn without such policies, some capitalists would lose their investments but their displaced workers would just move on to other lower paying jobs.

    Then why does unemployment appear especially during a downturn?

    While, for example, a minimum wage law, by itself, raised wages above market clearing, full employment levels, inflation could bring real wage rates back down to those levels.

    “If in the course of…inflation the rise in wage rates lags behind the rise in the prices of commodities, institutional unemployment may shrink or disappear altogether. But what makes it shrink or disappear is precisely the fact that such an outcome is tantamount to a drop in real wage rates.” Mises

    And, just as inflation brought real wages back down to market clearing, full employment levels, deflation would, in effect, drive them back up again, to unemployment levels.

    So, while inflation masked the unemployment effect of the preceding interventionist policy, deflation exposed it.

    But that wasn’t the same as causing it. It was still the preceding policies and not the deflation itself that was the real underlying cause.

    This answer to Prof. Krugman, by the way, is not permitted within the Austrian School itself, which would rather be defeated by an enemy from without than within.

    While Krugman is the enemy from without, as far as Steve Horwitz is concerned, DG Lesvic is the enemy within, and he hates me more than Krugman.

    As I read over the discussion at his blog, it just kills me to see that nobody there understands the problem, and that they've all virtually caved in to Krugman.

    How about you and I entering into a little conspiracy. Since I can't post at Coordination Problem, formerly Austrian Ecnomists blog, how about you doing it for me, posting this entry of mine, without mentioning my name. That will probably get you banned too from Horwitz blog, but won't a heroic fellow like yourself be willing to take that risk for science over censorship, economics over Horwitz' ego?

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  10. Daniel,

    Where the hell are you. You finally have a chance to do something useful, and you're nowhere to be seen.

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  11. A brilliant conspiracy! If you and I were closer in our views I might even indulge it, but I don't think so. If you're ever REALLY itching to say something, leave a comment on this blog about it and perhaps I'll post something to Coordination Problem like "a friend of mine saw this and remarked X", but I don't think I can be a conduit of yours on a regular basis :)

    I understand your argument - I think it makes perfect sense. I'm not sure how primary it is in all cases (unlike you, I do think deflation can cause unemployment on its own), but I think the simple observation that changes in the price level will adjust real wages is eminently sensible. Note that you are making an implicit assumption of sticky wages (ie - nominal wages are not adjusting to account for the inflation or deflation). That's fine - a lot of smart people think that sticky wages are important for precisely the reasons you lay out - but just be aware that your approach seems to be depending on nominal wage stickiness.

    But again - isn't this essentially a New Keynesian argument? Your heavy emphasis on things like the minimum wage may not be, but the idea that low inflation drives up real wages and leads to be unemployment (whether it "causes" or simply "reveals" is largely semantics) is at the very heart of New Keynesian Theory. You boil down all the cutsie New Keynesian insider-outsider, efficiency wage, sticky wage, or menu cost models and this is essentially what you get.

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  12. Steve Horwitz is an interesting guy. In most of my interactions with him on Coordination Problem and Cafe Hayek he seems perfectly nice and obliging. But he can tenaciously cling to some very odd ideas. I had a private email exchange with him over the oddest thing - just whether the impact estimates of the stimulus included jobs lost from the stimulus or just jobs gained (ie - net vs. gross job changes). I had to quote for him from the appendixes of several published reports that it was unambiguously a net job loss figure. It was a surreal email exchange for me. What economist would possibly think that published impact estimates represented gross changes rather than net changes? It made no sense at all, but he kept pushing and pushing.

    So he seems like a very nice guy (perhaps you'd disagree with me on that), but he does cling to some strange stuff sometimes.

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  13. Daniel,

    You wrote,

    "If you're ever REALLY itching to say something, leave a comment on this blog about it and perhaps I'll post something to Coordination Problem like 'a friend of mine saw this and remarked X.'"

    Go ahead! I am REALLY itching right now, just left the comment on this blog, and will bless your otherwise sorry ass right through the Pearly Gates if you will say, 'a friend of mine saw this and remarked...'

    But do you really have to say it was a friend of yours? Couldn't you just say "acquaintance?

    You wrote, or babbled:

    "I understand your argument - I think it makes perfect sense."

    No you don't.

    "I'm not sure how primary it is in all cases..."

    The issue is not whether it's primary or not but right or not.


    ",,,unlike you, I do think deflation can cause unemployment on its own..."

    How?

    "...but I think the simple observation that changes in the price level will adjust real wages is eminently sensible."

    I think what you meant to say was that, when prices in general fall, the prices of labor will fall along with the prices of other things.

    "Note that you are making an implicit assumption of sticky wages (ie - nominal wages are not adjusting to account for the inflation or deflation). That's fine - a lot of smart people think that sticky wages are important for precisely the reasons you lay out - but just be aware that your approach seems to be depending on nominal wage stickiness."

    How could I not have been aware of it. There was nothing implicit about it. I referred to minimuim wage laws, explicity.

    "But again - isn't this essentially a New Keynesian argument?"

    Not in the least.

    "Your heavy emphasis on things like the minimum wage may not be, but the idea that low inflation drives up real wages and leads to be unemployment...is at the very heart of New Keynesian Theory."

    If my emphasis on the miminimum wage laws was not Keynesian, nothing else was, for my whole thesis was based on the assumption of minimum wage or other such laws generating chronic, massive unemployment. Without them, there was no such unemployment, and nothing "Keynesian."

    "You boil down all the cutsie New Keynesian insider-outsider, efficiency wage, sticky wage, or menu cost models and this is essentially what you get."

    I don't know what you're talking about.

    Anyways, now you'll know how to defend me at Coordination Problem, which should really be called Credibility Problem.

    As for Steve Horwitz, whatever my own problems with him, he's one of the few really good men around, and I have great admiration and respect for him.

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  14. I kind of like where you're going with this but I think it's important to define what you mean by Keynesian economics. Obviously, that term means a lot of different things to a lot of different people. Mainstream Neo-Keynesian economics seems much further away from the Austrian school than, say, Post-Keynesianism. Post-Keynesians seems to emphasize uncertainty a whole lot more than Neo-Keynesians.

    So I guess I'm skeptical of how much synthesis there could be between typical IS-LM Neo-Keynesians and Austrians. But Post-Keynesianism, with its emphasis on uncertainty, endogenous money, and time (having to do with contracts and so forth) seems to definitely have some points of agreement with the Austrian camp.

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  15. Sam,

    You wrote,

    "I think it's important to define what you mean by Keynesian economics.

    Here was Richard Ebeling's definition of it, in his great new book, Political Economy, Public Policy and Monetary Economics/Ludwig von Mises and the Austrian Tradition, P 204.

    "Its two central tenets were the claim that the market economy is inherently unstable and likely to generate prolonged periods of unemployment and underutilized productive capacity, and the argument that governments should take responsibility to counteract these periods of economic depression with the various monetary and fiscal policy tools at their disposal."

    I don't know the difference between "Mainstream Neo-Keynesian economics" and "Post-Keynesianism," nor what "typical IS-LM Neo-Keynesians" means, nor anything about a "Post-Keynesian...emphasis on uncertainty, endogenous money, and time (having to do with contracts and so forth)."

    But, speaking for myself, at least, and, I believe, Mises, too, if not for the whole Austrian School: the market tends not toward unemployment but full employment, and the "gov" should not intervene in it at all but stay out of it altogether.

    So, whatever any "points of agreement" you may find between the Keynesian and Austrian camps, there were certainly none of any significance between Keynes and Mises themselves.

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  16. Daniel,

    Where are you now? Have you disappeared on us again? For godsake, man, this is your blog. Take care of it!

    I see you still haven't rescued those poor souls at Coordination Problem from their Krugman dilemna. What the hell are you waiting for?

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  17. Daniel,

    You wrote,

    "I don't think I can be a conduit of yours on a regular basis."

    Look at this way. I shall be the Cyrano to your Christian, the Newman to your Kramer, and you shall walk away with the lovely Roxanne or Pam.

    Hey, man, if you could set me up with Sophia Loren, I wouldn't be saying that "I don't think I can be a conduit of yours on a regular basis."

    I'd tell you to lead me to that old broad.

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  18. Daniel,

    I'm about ready to file a missing persons report, send out a search party, send out the St Bernards.

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  19. Folks,

    I hate to report this, but the dogs have just come back with what appears to be a very fat head.

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  20. DG Lesvic may need to start looking for a posting conduit for this blog, if he doesn't stop loitering so noisily. ;)

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  21. I didn't say it was Daniel's head, and I'm sure glad to know that it wasn't Evan's.

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  22. Evan,

    I have to admit that I have been as obnoxious as I possibly could, which, as Daniel can tell you, is pretty obnoxious, and that, if you decide to banish me, I will have gotten just what I asked for.

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  23. But I am really asking that you let me stick around and keep being obnoxious.

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  24. Daniel and I aren't really big on banning, or imposing much of any posting rules. I wouldn't worry. It's pretty difficult to make the gods angry at F&OST.

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  25. I'm not worried about any gods, just assholes.

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  26. ...as if the two are mutually exclusive? ;)

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  27. I'm torn, Evan. For one thing, DG is a lot better behaved than he has been elsewhere. I've rather enjoyed reading him so far, and nobody's been called a fascist or a socialist. We've avoided the real brutality. Plus he hasn't really impeded any conversations by other guests (which would be bothersome).

    On the other hand, whenever he gets kicked out of a blog, he goes out of his way to let other people on other blogs know about it. That sounds like free advertising for us to me. Perhaps a reason to consider it.

    DG - we'll powow and get back to you about your fate.

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  28. I think some pretty good arguments can be made for fiscal and monetary stimuli from an Austrian perspective, I just don't think that many self-identified Austrian economists try to present their opponents' views in a favourable light. If one's aim in the pursuit of truth, then it seems to me that making the case for an opposing view as strong as possible is important.

    I hope to never be accused of arguing against a strawman.

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  29. Daniel,

    I'm counting on your good nature to let me stay and be my real self, which I can't be anywhere else, the little bastard only you could love.

    Kelly,

    On every other issue, you have been terrific, but on this one, you have been like Rasputin, shot, strangled, and drowned, but still popping up. Sorry, but I'm worn out from murdering you.

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  30. Well, what's the verdict? For goddsakes, don't keep me hanging like this! Have you no decency?

    And, by the way, sorry I forgot the fascist and socialist business. I promise not to let that happen again.

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  31. I'm sorry, but the suspense has just been too much for me.

    Goodbye, cruel world.

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  32. OK - we've decided. You're safe for now, DG. Sorry for the delay - it's a long drawn out process. Lots of forms to fill out, and lawyers. Plus the decision got appealed a couple times. But it's finalized now. Welcome to the blog.

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  33. I just posted this at Coordination Problem, as a comment to Latest Volume in Advances in Austrian Economics by Steven Horwitz:

    "How would you know about advances in Austrian Economics when you systematically exclude them?"

    Wanna bet that it won't still be up there by the time you get to it?

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  34. You've got one helluva martyr complex, buddy. And I'm intrigued that we've become an outlet for broadcasting it.

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  35. You shouldn't need a divinity school education to realize that this has been God's purpose for you all along.

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  36. How is it that Daniel, who is so verbose on other people's blogs, has hardly anything to say on his own? Maybe, by the time he's finished at the others, he's too worn out for his own. Or perhaps he's intimidated by Evan, just like I am. Though it isn't really Evan, it's God.

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  37. Onward Christian Soldiers,
    marching as to war,
    with the cross of DG...

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  38. Daniel,

    Have I shut you up?

    If so, how did I do that?

    Russ Roberts would sure like to know.

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  39. Daniel,

    I enjoyed beating up on you again over at Cafe Hayek, but have really missed the opportunity to do so here in your own parlor.

    Come into your parlor, said the spider to the fly.

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  40. Daniel,

    What's the matter?

    Is it something I've said?

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  41. Daniel,

    Just to let you know I'm still here, and you better still stay indoors behind your mama's or your brother's apron.

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  42. Daniel,

    Just ran across a discussion you were involved in, at The Freeman, on the subject, The Depression You've Never Heard of: 1920-1921.

    I would certainly like to enter that discussion, with you and your adversary, Jonathon Finegold Catalan, but don't know how to access The Freeman, and don't know the other site at which you and he have been discussing this.

    Could you clue me in to those sights, or would you like to discuss it here?

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  43. I would suggest that the best way to begin any kind of synthesis of Austrian economics with Keynesianism would be to look first at the early Austrian school.

    The first thing you find is that a number of the first/second generation Austrians were Fabian socialists or at least sympathetic to Fabian socialism:

    http://socialdemocracy21stcentury.blogspot.com/2011/06/why-are-there-no-austrian-socialists.html

    Why was that? And why did Austrians like Eugen von Philippovich and Friedrich von Wieser regard their Austrian economics as compatible with a progressive liberal state and state intervention?

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All anonymous comments will be deleted. Consistent pseudonyms are fine.