Tuesday, November 15, 2011

Brad DeLong issues a challenge to Austrians

"I would like to hear an alternative theory as to where this mammoth #economictheoryfail [i.e., Mises's theory of the business cycle] comes from--other than the theory that it comes from enslavement to a naïve cost-of-production theory of value, according to which gold-backed money's value is in some sense "real" because of the resource cost of mining, while fiat money's value is in some sense "fake" and thus bound to cause trouble [Brad's guess]."

As most of you know, my macroeconomics is generally in agreement with Brad's. But my interpretation of Mises is somewhat different from his. Mises, following Menger, clearly doesn't have a cost of production theory of value. It's really much simpler than that. It's not that gold mining is more genuine because you have to work at it. It's simply that gold represents a fixed measure of value. And for Mises, not only is that acceptable - it's preferable. Otherwise, adjustments of the money supply create the illusion of artificial wealth, which for Mises would distort market signals.


This is all fine as far as it goes. Brad DeLong doesn't want to distort market signals, after all - and neither do I. We are market-friendly guys. The problem is that in a world where people demand money for its liquidity, the interest rate is going to be influenced by the amount of whatever thing we artificially ascribe the qualities of "money" to. The amount of loanable funds available for investment are going to be determined by this interest rate, and the level of investment is going to be determined when entrepreneurs compare their probable rates of return to this interest rate. This means that the amount of money out in the world may be at such a level that there will be too few loanable funds available for investment (or, the same thing, too much kept liquid) to be consistent with full employment.

Ultimately all money is artificial -or to put it better - all money is a social construction. There is nothing intrinsic or natural about the stuff. It is perhaps the quintessential social construction. Mises is concerned about an artificial distortion of market signals, and that's a reasonable concern under certain circumstances. But I'm also concerned about an artificial underutilization of factors of production, which is only occurring because there are not enough little green pieces of paper with dead white men on them circulating. If we were to compare competing artificial distortions here, it seems to me resource underutilization is the one we're most at risk of suffering from.

That makes me a market monetarist/quasi-monetarist.

What makes me a Keynesian is that I actually think one of the major problems we're facing is that the act of saving and the act of investing are done by separate people, and that while people may want to provide a lot of loanable funds right now, investors don't have work to be done that earns a worthwhile rate of return. To a large extent, this is a vicious cycle. There's nothing to invest in because demand is weak. But demand is weak because there is not enough to invest in. Even if this equilibrates - even if income gets ground down through the paradox of thrift to the point that the loanable funds market clears, there's still no reason to expect that it will clear at a full employment level.

I do know of one consumer of loanable funds that has a lot of worthwhile stuff it can do. This economic agent is not reliant on the profit motive, so its ability to do useful things is not constrained by weak prospective demand. This economic agent knows that a school provides value, that scientific advances provide value, that infrastructure provides value - despite current constraints on other utility-maximizers' ability-to-pay and willingness-to-pay.

The profit-maximizers say "if nobody wants to buy from me then the profit-maximizing choice is to sit on something with a zero rate of return than invest in something with a negative rate of return". Only a non-profit-maximizing agent can say "I don't measure benefit by the excess of revenue over costs, and this money is cheap right now - I have things to do with it".


Now I think I have homework to get back to.


  1. How does having a monetary policy that takes into consideration the expectations of people make you a "market monetarist", Daniel? As you are aware, Baron Keynes NEVER abandoned monetary policy or considered it impotent - and he did pay attention to both nominal and real values.


  2. I would consider Keynes a market monetarist too.

    Keynesians - including Keynes - may hesitate about the extent of the effectiveness of monetary policy at any given point (even if it still works at the zero lower bound, certainly it loses at least one mechanism through which it typically works!). But as you say I don't think it's easy to find Keynesians who give up on it as being useless (perhaps some of the early Keynesians)?

    I see the whole quasi-monetarist perspective as being a very big umbrella of post-Say's Lawers (for lack of a better term).

    When I say I'm a Keynesian, that wasn't meant to be a renunciation of quasi-monetarism.

  3. I personally feel that to say yes to one or the other is stupid, and I also feel that the term "monetarist" is overrated. That's why I reacted the way I did.

    But you do realize that the economics of Keynes and Keynesianism are not quite one and the same, right? Although Keynes may have endorsed IS/LM as a convenient compromise (see Skidelsky's "The Economist as Saviour"), there's still more to it.


  4. re: "But you do realize that the economics of Keynes and Keynesianism are not quite one and the same, right?"


    Indeed, I'm not sure Keynes ever got around to accepting IS-LM, did he?

    The point I always make here is that the differences are real but largely academic. I do not ascribe as much import to the differences as - for example - many of the Post-Keynesians do.

  5. These are not laws of such precise mechanical determinism that adjustment in the theory over time indicates a fundamentally different insight. This is a complex system we're studying, and the processes that Keynes identified are broadly speaking the processes that Keynesians still talk about. That's what's important in my view.

    Might Keynes have had a different specific idea that Keynesians have been unwise to abandon? Certainly.

    Might Keynes have missed a point that Keynesians have been right to add or clarify? Certainly.

    But the basic process highlighted by Keynes and the Keynesians is what is of real importance.

  6. Keynes supported the endogenous money approach and thus considered the 'loanable funds' aspect of the theory of investment to be erroneous, as investment created its own savings regardless of what people had deposited in financial institutions. Unfortunately, he didn't make this clear until after TGT:

    Planned investment—i.e. investment ex-ante—may have to secure its “financial provision” before the investment takes place; that is to say, before the corresponding saving has taken place. This service may be provided either by the new issue market or by the banks ;—which it is, makes no difference… let us call this advance provision of cash the ‘finance’ required by the current decisions to invest. Investment finance in this sense is, of course, only a special case of the finance required by any productive process; but since it is subject to special fluctuations of its own, I should (I now think) have done well to have emphasised it when I analysed the various sources of the demand for money.

    He was thus committed to a 100% liquidity preference theory of the interest rate.

  7. re: "He was thus committed to a 100% liquidity preference theory of the interest rate."

    Right - this is my understanding, which I've primarily gotten from an article of his - I think it was called "Alternate Theories of the Interest Rate" or something like that where he discusses Hicks. Is that what this is from?

    I'm a little hazy on how endogenous money makes the loanable funds approach erroneous - could you sketch that out a little more?

  8. @Daniel Kuehn: Well, according to Lord Skidelsky's second volume of the biographical trilogy, he didn't, but he accepted it as a "compromise" of sorts.

    @unlearningecon: I'm not sure if Keynes actually regarded the money supply as purely endogenous. In practice, the money supply is both endogenous and exogenous, in any case.

  9. Daniel,

    He mentions in multiple papers - his 1937 paper, 'The General Theory of Employment', could well be interpreted as an attack on IS/LM as reassertion of his own theory. Geoff Tily explores how IS/LM was effectively developed by economists other than Keynes and was completely opposed to him.

    'I'm a little hazy on how endogenous money makes the loanable funds approach erroneous - could you sketch that out a little more?'

    Loanable funds = the money available to be loaned out. But since funds are not required to facilitate new loans, this doesn't make much sense. At least that;s the way I understand it.

    Blue Aurora,

    Of course, the money supply is not 100% endogenous. But it makes more sense to me to model it as endogenous and then 'tack on' the Central Bank than vice versa.

  10. Daniel, let's see if you can pass the Murphy Turing Test by now. Do you see how DeLong's alleged third propositions (which he attributes to Misesians) is the very thing that bothered me about Keynes' dig against the gold standard a few weeks ago?

    I.e., no Misesian ever said, "The way to cure a depression is to go dig up some more gold."

  11. Daniel, here is how I understand it.

    Jewelers need gold to make jewelry.

    A man who hoards several commodities for future use starts keeping gold to get future goods or favours from the jeweler.

    Other people start keeping gold to get goods or favours from the man who resells gold to jewelers.

    And so on. I doubt cost of production theory of value has anything to do with it. It's about people having a double coincidence of wants; someone who doesn't have enough gold for making jewelry wants gold and someone who doesn't have enough jewelry for luxury wants jewelry - and that's how it all goes round.

    The hypothesis I stated above has zero historical basis, because MMT accurately describes how money has existed since ancient times. However, the purpose of such assumptions is obviously not to describe history, but see how accurately they mirror or predict real world behaviour. Given that speculators often hoard cocoa beans for resale in the future when cocoa prices are shooting up as they are now, they are almost treating them too like money in the bank. It starts with people like me demanding cocoa because they like chocolates, and then it ends with people demanding cocoa for hoarding because people like me like chocolates.

  12. Daniel what do you mean that gold measures a fixed level of value?

  13. sorry i made a typo on that, but you know what i'm referring to

  14. "It's simply that gold represents a fixed measure of value."

    That's wrong. Mises explicitly said that money does NOT "measure" value. See his Theory of Money and Credit. Also its purchasing power is NEVER "fixed".

    The benefit of money in general is that it facilitates indirect exchange and economic calculation. However, since the purchasing power of money is never stable, economic calculation can never be perfect.

    Mises said the chief benefit of commodity money in particular is that it cannot be increased ad libitum by governments.


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