I’ve long promised a post on Austrian Business Cycle Theory, and here it is. For those who would rather get straight to the conclusion, it’s one I share in broad terms with most of the mainstream economists who’ve looked at the theory, from Tyler Cowen , Bryan Caplan
and Gordon Tullock at the libertarian/Chicago end of the spectrum to Keynesians like Paul Krugman and Brad DeLong.
To sum up, although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas.
The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma. Like all such dogmatic orthodoxies, it provides believers with the illusion of a complete explanation but cease to respond in a progressive way to empirical violations of its predictions or to theoretical objections. To the extent that anything positive remains, it is likely to be developed by non-Austrians such as the post-Keynesian followers of Hyman Minsky.
Update There’s a fascinating discussion linking to this post here. In French, but clear and simply written. Anyone with high school French and a familiarity with the issues should be able to follow the main points.
First, some history and data. Austrian Business Cycle Theory was developed in the first quarter of the 20th century, mostly by Mises and Hayek, with some later contributions by Schumpeter. The data Mises and Hayek had to work on was that of that of the business cycle that emerged with industrial capitalism at the beginning of the 19th century and continued with varying amplitude throughout that century. In particular, it’s important to note that the business cycle they tried to explain predated both central banking in the modern sense of the term and the 20th century growth of the state. The case of the US is of particular interest since the business cycle coincided with a wide range of monetary and banking systems: from national bank to free banking, and including a gold standard, bimetallism and non-convertible paper money.
This NBER data goes back to 1857, but there was nothing new about the business cycle then (Marx, for example, had been writing about it for a decade or more). The US experienced serious “panics”, as they were then called in 1796-97, 1819 and 1837 [1] as well as milder fluctuations associated with the British crises of the 1820s and 1840s.
The typical crisis of the 19th century, like the current crisis, began with bank failures caused by the sudden burst of a speculative boom and then spread to the real economy, with the contraction phase typically lasting from one to five years. By contrast, recessions since 1945 have generally lasted less than a year, and have mostly been produced by real shocks or by contractionary monetary and fiscal policy.
According to the theory, the business cycle unfolds in the following way. The money supply expands either because of an inflow of gold, printing of fiat money or financial innovations that increase the ratio of the effective money supply to the monetary base. The result is lower interest rates. Low interest rates tend to stimulate borrowing from the banking system. This in turn leads to an unsustainable boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas that would not attract investment if price signals were not distorted. A correction or credit crunch occurs when credit creation cannot be sustained. Markets finally clear, causing resources to be reallocated back towards more efficient uses.
At the time it was put forward, the Mises-Hayek business cycle theory was actually a pretty big theoretical advance. The main competitors were the orthodox defenders of Says Law, who denied that a business cycle was possible (unemployment being attributed to unions or government-imposed minumum wages), and the Marxists who offered a model of catastrophic crisis driven by the declining rate of profit.
Both Marxism and classical economics were characterized by the assumption that money is neutral, a ‘veil’ over real transactions. On the classical theory, if the quantity of money suddenly doubled, with no change in the real productive capacity of the economy, prices and wages would rise rapidly. Once the price level had doubled the previous equilibrium would be restored. Says Law (every offer to supply a good service implies a demand to buy some other good or service) which is obviously true in a barter economy, was assumed to hold also for a money economy, and therefore to ensure that equilibrium involved full employment
The Austrians were the first to offer a good reason for the non-neutrality of money. Expansion of the money supply will lower (short-term) interest rates and therefore make investments more attractive.
There’s an obvious implication about the (sub)optimality of market outcomes here, though more obvious to a generation of economists for whom arguments about rational expectations are second nature than it was 100 years ago. If investors correctly anticipate that a decline in interest rates will be temporary, they won’t evaluate long-term investments on the basis of current rates. So, the Austrian story requires either a failure of rational expectations, or a capital market failure that means that individuals rationally choose to make ‘bad’ investments on the assumption that someone else will bear the cost. And if either of these conditions apply, there’s no reason to think that market outcomes will be optimal in general.
A closely related point is that, unless Say’s Law is violated, the Austrian model implies that consumption should be negatively correlated with investment over the business cycle, whereas in fact the opposite is true. To the extent that booms are driven by mistaken beliefs that investments have become more profitable, they are typically characterized by high, not low, consumption.
Finally, the Austrian theory didn’t say much about labour markets, but for most people, unemployment is what makes the business cycle such a problem. It was left to Keynes to produce a theory of how the non-neutrality of money could produce sustained unemployment.
The credit cycle idea can easily be combined with a Keynesian account of under-employment equilibrium, and even more easily with the Keynesian idea of ‘animal spirits’. This was done most prominently by Minsky, and the animsal spirits idea has recently revived by Akerlof and Shiller. I suspect that the macroeconomic model that emerges from the current crisis will have a recognisably Austrian flavour..
Unfortunately, having put taken the first steps in the direction of a serious theory of the business cycle, Hayek and Mises spent the rest of their lives running hard in the opposite direction. As Laidler observes, they took a nihilistic ‘liquidationist’ view in the Great Depression, a position that is not entailed by the theory, but reflects an a priori commitment to laissez-faire. The result was that Hayek lost support even from initial sympathisers like Dennis Robertson. And this mistake has hardened into dogma in the hands of their successors.
The modern Austrian school has tried to argue that the business cycle they describe is caused in some way by government policy, though the choice of policy varies from Austrian to Austrian – some blame paper money and want a gold standard, others blame central banks, some want a strict prohibition on fractional reserve banking while others favour a laissez-faire policy of free banking, where anyone who wants can print money and others still (Hayek for example) a system of competing currencies.
Rothbard (who seems to be the most popular exponent these days) blames central banking for the existence of the business cycle, which is somewhat problematic, since the business cycle predates central banking. In fact, central banking in its modern form was introduced in an attempt to stabilise the business cycle. The US Federal Reserve was only established in 1913, after Mises had published his analysis.
Rothbard gets around this by defining central banking to cover almost any kind of bank that has some sort of government endorsement, such as the (private) Bank of England in the 19th century, and arguing for a system of free banking that would avoid, he asserts, these problems. But, on any plausible definition of the term, the US had free banking from the Jackson Administration to the Civil War and that didn’t stop the business cycle (Rothbard offers some historical revisionism to argue that the Panic of 1837 didn’t really happen, but that wasn’t what US voters thought when they threw the Jacksonians out in 1840). And free banking in late 19th century Australia (our first quasi-central bank was the Commonwealth Bank established in 1915) didn’t prevent a huge boom and subsequent long depression around 1890. Overall, the US was much closer to free banking throughout the 19th century than in the period from 1945 until the development of the largely unregulated ‘shadow banking’ system in the 1990s, but the business cycle was worse then (how much worse is a matter of some controversy, but no serious economist claims it was better).
To sum up, the version of the Austrian Business Cycle Theory originally developed by Hayek and Mises gives strong reasons to think that an unregulated financial system will be prone to booms and busts and that this will be true for a wide range of monetary systems, particularly including gold standard systems. But that is only part of what is needed for a complete account of the business cycle, and the theory can only be made coherent with a broadly Keynesian model of equilibrium unemployment. Trying to tie Austrian Business Cycle Theory to Austrian prejudices against government intervention has been a recipe for intellectual and policy disaster and theoretical stagnation.
John Quiggin 
A closely related point is that, unless Say’s Law is violated, the Austrian model implies that consumption should be negatively correlated with investment over the business cycle, whereas in fact the opposite is true.
Not sure where you get this from. Obviously, if new money is the cause of lower interest rates, consumers clearly aren’t saving more, but continuing to spend at the same rate. Thus, there is no inevitable increase of capital goods (nor decrease of consumer goods), but an inflationary pressure on capital goods until the malinvestment is realized. Only once the bubble bursts does consumption go down, just like we experience in reality, although mainstream economists keep bringing up the mythical “Paradox of Thrift”.
Consumption would go down if it was actual savings that was driving lower interest rates instead of monetary infusions, because people would be saving more for future consumption.
Still, I’ll give you credit for a better understanding of Austrian economics than Krugman, et al.
I’ve read most of the comments and I believe several points have been missed- I haven’t read them all so excuse any redundant answers.
All quotes from the original post
“The typical crisis of the 19th century, like the current crisis, began with bank failures caused by the sudden burst of a speculative boom and then spread to the real economy, with the contraction phase typically lasting from one to five years. By contrast, recessions since 1945 have generally lasted less than a year, and have mostly been produced by real shocks or by contractionary monetary and fiscal policy.”
Noting a shorter recession/depression period during that segment of the business cycle is not in conflict with ABCT. If you take ABCTs core- that malinvestments have occurred and that capital must be reallocated- one would predict that technological innovations which allowed for greater (faster, more accurate and reliable) dissemination of information and the faster transportation of physical capital would shorten the recession. First the speed and breadth of information spreading out allows for more entrepreneurs to analyze and bid on a defunct company while the speed will also allow a shorter turnover time which will lessen the depreciation of capital stock. Can you really compare the length of time of recessions from an age where the telegraph was in its infancy to a period where any individual with an internet connection/TV could have heard about Lehman Brothers filing for bankruptcy within minutes of the occurrence?
“A closely related point is that, unless Say’s Law is violated, the Austrian model implies that consumption should be negatively correlated with investment over the business cycle, whereas in fact the opposite is true. To the extent that booms are driven by mistaken beliefs that investments have become more profitable, they are typically characterized by high, not low, consumption.”
I don’t know what your interpretation of Say’s law is so I don’t know how you think it must be violated but I will present a short explanation of why I(nvestment) and C(onsumption) are positively correlated during the boom. Again it goes back to the core of the Austrian argument- that action X causes investments to appear more attractive than they are. The higher expectations appear to be confirmed by the flood of money and or credit which continues to drive up asset prices producing high returns. These higher asset prices allow for two things to happen, first it convinces those holders of assets that they have more wealth than they can (as a group) actually realize. This encourages them to increase their consumption to equal their level of assumed wealth. The method they choose is invariably to borrow money for this consumption? Why? Because the low interest rates combined with higher returns on investments encourage borrowing over dipping into savings. If you believe you will get an 8% return in the market you are better off borrowing at 5% and leaving your money in the market than you are selling your stock and paying cash for what ever goods you want.
The second thing that the high asset prices do is they convince banks that their loans are safer thanks to the extra collateral their customers have. We saw this during the housing bubble where people would take out home equity lines and spend that money on cars, crafts, boats and braces. Thus the credit expansion first starts blowing up an investment bubble but then spills over into fueling consumption as well.
“Finally, the Austrian theory didn’t say much about labour markets, but for most people, unemployment is what makes the business cycle such a problem.”
The Austrian theory says plenty about labor markets- simply put labor requires capital to be productive. When a misallocation of capital is realized that capital must be put to a different use and this reallocation requires time. Secondly the laborer himself must retrain to meet the needs of relocated capital which also takes time (this process also requires a reasonable guess as to what jobs will be in demand when the capital is reallocated).
While lower interest rates can, although not necessarily do, relax lending standards, that is not the only way. Higher velocity can as well and the central bank has even less control over that than money. It seems evident from experimental work that bubbles are inherent to market processes. It is possible the central bank can’t really prevent them, that the most they can do is redistribute their occurrence, frequency, and magnitude, but if it is possible to make them worse it should also be possible to make them better. While accidents may happen, our actions in response need not be accidental.
“I’d also like to ask John why it’s a crime for Austrians to have internal disagreements. And if we didn’t, wouldn’t we be accused of being (that much more…) dogmatic and cult like than we are already accused of?”
I have a couple of problems. First, in relation to this post, I’ve been accused several times of being utterly ignorant because my summary reflected an Austrian view but not the one the commenter held (Greg Ransom has been the worst offender, but several others have done the same). My responses have reflected this.
Second, the problem is that the internal disagreements don’t detract at all from the dogmatism with which views are presented. Again, most commenters above , and most I’ve seen elsewhere, write as if Austrian economics represents a complete solution to all economic problems, wilfully disregarded by mainstream economists for nefarious reasons. It’s only in a discussion like this that it emerges that each of these people is giving their own private interpretation of the term “Austrian economics”.
As I’ve indicated in the post, there are some important ideas here, and I concede that there is still some active work going on developing the ideas put forward by Mises and Hayek. But the discussion above indicates pretty clearly in my view that the whole idea of an “Austrian school” is an obstacle to intellectual progress as far as business cycle theory is concerned.
I guess I’ll close with this John:
I agree at one level in that Austrians should be just “doing” good economics and not worrying whether it adheres to some pre-determined notion of what is and isn’t doctrinally pure. Schools of thought have a way of promoting such purity. But schools of thought also have value as signals about how people do what they do. Saying it’s “an Austrian perspective” communicates something of value.
The problem, IMO, is that lots of people run around calling themselves “Austrian economists” who are, in fact, not economists but fairly well-read “laypeople” who think that they know economics because they read some books by Mises, Hayek, etc. I know I sound like an arrogant academic to them, but that’s no substitute for the work that professionally trained economists go through to get a PhD and continue to produce journal-quality research.
I would only ask of your readers that if they wish to formulate a view of either the substance or the personalities of Austrian economics/economists that they deal with the work that has been published in professional journals (both Austrian and non-Austrian) and books from known publishers. Or better yet, come to one of the several professional meetings where Austrians present their work (the Southern Econ Ass’n in the US, as well as various history of economic thought societies across the world, among others) and hear what is said and how people behave and then decide what you have.
Judging the serious work of Austrian economists by blog commenters is not the way to go. I include my own comments in that contention. 🙂
Steve,
I don’t think many of us well-read “laypeople” are going to take offense at that or think you are arrogant. In fact, most of us would prefer to defer to the professionally trained economists like yourself. However, many of us feel that some of the work of academics that have real world implications and applications are popularized in the blogosphere. In the absence of professional participation in the little mini-battles of ideas that are taking place, people like me do the best we can to ‘defend and defer’ (of course some pretend to be experts, which is not helpful).
All that is to say, your comments are spot on, and if anyone accuses you of being an arrogant academic, then, well, so what?
hayek vs. mises…pepsi vs. coke! both good drinks.
i’ll now read prof. horwitz’ paper and make my own mind up as to its worth. as a personal critique, he’s the only contributor who’s pulled rank to bolster his arguments. shows weakness, not arrogance.
he’s all at sea if he imagines that this movement will ripple out from the universities (let the record show how marginal austrian economics is in the academic sphere: most undergraduates never even hear the word “austrian”).
rather, it’s likely that academe will be forced to accommodate these ideas by the lay public, disenchanted with the macroeconomics that we’ve been served for generations.
What I like is to see ideas from different economic theories, being debated and within theories being debated, rather than just the claim that one is infinitely superior (so there!!).If it wasnt beneath Keynes and Hayek to enter debates, with their different views, then why raise the dividing walls with suspician and or blame. Any advance no matter how small etc.. If anything it seems to me that both the Neo Keynesians and the Austrians are not happy with current economic policies either dealing with the GFC or leading up to it (like a lot of well read “lay people”). Its been very interesting thanks to JQ and the participators here.
I didn’t pull rank to bolster my arguments. I pulled rank to better define Austrian economics. My argument stands or falls on its merits. But if people want to know what Austrian economics as a school of economic thought, they best be reading what professional economists have to say, regardless of which flavor Austrian they are.
i’ll drink to that!
I would be more likely to defer to “professionally trained economists” if they actually predicted the worst financial calamity in 70 years. You would think all that academic training would at least allow them to see a disaster coming in their area of speciality.
If a doctor said “only look at my preferred academic medical journals when thinking about disease” and those journals we discussing the finer points of opthamology when the Black Plague was taking out 90% of the population and death was all around us, you would consider the doctor (1) had no perspective (and was possibly morally blind); and (2) had a very (very!) narrow mind.
were not we.
My blunt suggestion: If any academic economist did not predict and did not warn about the current financial crisis and describe in broad terms what was going to happen, they should resign and look to another line of work. Like data entry, or accounting. Or street cleaning.
#161. It’s true that hardly anyone got both the timing and the magnitude right.
But most Keynesians (including me) were pointing to the massive imbalances, housing bubbles and so on, and saying that they couldn’t last. Austrians said the same thing, with different emphases, which is one reason I’m engaging with them more seriously, and the mainstream free-market economists (most of whom denied that there were any problems) less so.
I think in future all academic economists should preface their comments by specifically referring to one published paper or article they wrote PRIOR to the GFC where they warned about excesses in financial markets (including Steve).
If they cannot point to one article where they wrote and warned about this, ignore them as economic quacks.
The disaster was so obvious and it’s effects so profound, any fully trained academic economist who did not warn about the calamity should rip up their “degrees” or be considered practicing voodoo artists or charlatans.
Academic Economists: It’s time to put up (your articles prior to the GFC) or shut up.
I think this was a really great, informative thread. For whatever reason, Austrian economics (at least on the internet) attracts more than its fair share of cranks and fanatics. It was very interesting to hear the Austrian perspective by its actual practitioners.
One thing I don’t understand about the argument is even if there is malinvestment, why is liquidating the investments so costly? (I assume there’s more to it than just running down inventories.) A malinvestment is just a sunk cost, right? I can how if you accept the argument you would believe that the central bank causes a misallocation of resources, but I don’t see why when that misallocation ends you would see a recession.
There’s no one to buy the misalloction. These HUGE investments have in fact been stimulated into existence by FRB distorting price signals.
Houses have no buyers. No one wants to borrow to buy useless resources. That results in an economy-wide slump.
Check out YouTube. You can see banks demolishing BRAND NEW houses in California after being foreclosed. Where will the housebuilders go now?
A living breathing example of ABCT. And the tremendous damage of unfettered FRB (a.k.a financial fraud).
Fair enough ABOM, but any economist who has models to predict the behavior of markets is probably too busy spending their massive wealth to bother with commenting on blogs.
it will be interesting to see if steep price rises in both consumer and producer indices in the next couple of years will cause some to question the current monetary orthodoxy. (so far, the reserve bank of australia enjoys god-like status, notwithstanding the cracking money supply growth).
at what price will the “barbarous relic” cease to be barbarous?
to walt:
further to the comments of a.b.o.m., the investments that are revealed in the bust as errors include human capital – the careers of many people, deceived into thinking that the world would continue to demand x number of personal trainers, big tv technicians, realtors etc.,ad infinitum.
the distortions originated in the monetary sphere, but their effects have spread to every part of the economy. having to change one’s line of work can be a painful and time-consuming process.
Joseph – It’s not rocket science to predict a crash as big as the 1930s and I’m not expecting the moon here. I’m asking for basic competence in the area of “science” these guys practice in.
We’re not talking about accurately estimating the Dow at the end of the year (something economists are asked to do by the way, which I think is ridiculous).
If you’re saying academic economists should not be expected to warn of systemic crises or crashes as big as the current GFC, then what the H*ll are they good for???
You didn’t need a model to predict this was all going to end in tears Joseph, it’s just another credit boom gone wrong. Only the numbers are bigger.
ABOM & sdfc,
Maybe economics isn’t a predictive science. I don’t think it’s fair to expect people to predict a system that changes whenever you figure it out. Imagine if physics were like that!
ABOM I demand a similar level of evidence from academics, only instead of journal publications with predictions I expect to see billions and billions of dollars.
It isn’t really the malinvestment that is the problem; those are sunk costs. It is the debt left over from them. Attempting to liquidate it can result in deflation and the ridigity of debt then results in a vicious cycle. Inflation is positive by allowing debt to be liquidated easing the drag on the economy of liquidation.
Joseph – I thought I was demanding! There’s a difference between a successful horse trainer and a successful betting man. I compare economists to horse trainers – able to see what will work and what will not, “coaching” government representatives to do the right thing to get their economies back on track. They should be able to see what is wrong and right with an economy just like a trainer sees a good or bad horse.
That is a different skill to a betting man. A betting man may make a fortune because of blind luck.
A trainer may not be a millionaire.
There’s a difference that you don’t quite see.
It’s same old argument many “materialists” shoot back at academics, which I think is profoundly misguided “If you’re so smart why aren’t you rich?”
The answer is: Often the rich are plain lucky.
The better answer is: I am already rich. On the inside. So I don’t need what you call “money”.
ABOM
Lord has it right it is the debt that is the problem not the misallocation. This:
“Houses have no buyers. No one wants to borrow to buy useless resources.”
is just silly. People did want to buy them, and the houses aren’t useless. It is just that the people that bought them couldn’t afford them at the price they paid. I argued on interfluidity that if you look at housing investment stats and the area above and below the trend line then any “over-production” has already been offset. But people still aren’t buying.
We need a theory of leveraged speculation (Minsky perhaps) to explain what has happened not mal-investment (which happens anyway quite often without a boom).
Look,
one problem I have with market worshippers is that their equilibrium clearing mechanism requires negative feedbacks, but common sense says there are also positive feedbacks and that if those positive feedbacks are not damped they with come to dominate in the end. I see two possible damping mechanisms, active control or automatic rule based controls. Austrians put their faith in rule based controls – but who sets them up and callibrates them?
baconbacon
Thanks for your post which gives a view of the issue at hand that is clearer than most people have given. It still leaves me floundering a bit however, because obviously
1. Consumption and Investment can only rise concurrently if their are unemployed resources to start with (which is why of course the central bank has lowered interest rates). So your argument can only apply to large amplitute cycles with fairly dramatic central bank intervention (since very short interest rates have modest direct effects on the longer rates that impact investment decisions.
2. You don’t seem very clear in distinguishing between the price of existing assets and the cost of new investment – which means to me you are drifting aware from the story of malinvestment.
3. I’m quite interested in the idea that it is land prices that drive the big cycles, I seriously think we should be digging out and rereading Henry George more than von Mises or Hayek (whose best observations have been incorporated into the mainstream). You don’t even mention them. I remember being very impressed in 1990 in the UK seeing “for Rent” signs on almost every building in Regent Street and thinking how much changes in rents can correct for financial flow of funds problems, and wondering why the landlords preferred to have their clients leave rather than lowering the rent to what they afford at the time. (I know that most rent contracts had “increase only” clauses!)
Oops
… aware from the story … should read … away from the story …
Overall,
the discussion gradually seems to be getting better. And I’m left wondering like JQ – is the label “Austrian” useful? And also that I would like to see a bit more modesty and uncertainty coming from the “Austrian” supporters, given that there is so much disagreement, even within their own ranks.
ABOT,
Again, maybe. I think an economist can be useful without having to make market predictions. The necessity for predictions is part of a science fetish that is very toxic to economics and can only end with public disillusion with the profession. And that would be a shame because economic theory has a lot more to offer.
newson #169
“further to the comments of a.b.o.m., the investments that are revealed in the bust as errors include human capital – the careers of many people, deceived into thinking that the world would continue to demand x number of personal trainers, big tv technicians, realtors etc.,ad infinitum.
the distortions originated in the monetary sphere, but their effects have spread to every part of the economy. having to change one’s line of work can be a painful and time-consuming process.”
Now I for one, worry very seriously about the long term prospects for a particular industry when thinking about what job or career to choose. Why wouldn’t other people? I don’t think most people are fools. (This is one reason that there may be severe temporary shortages of some skills). And given the ubiquity of technological change, surely, monetary policy is not the only source of this problem. The fact is every new industry goes through a hysterises curve of adoption in which in the middle (fad) stages some problems with skills shortages will arise and in the saturation stage some excess will occur.
“please note that those austrians opposed to frb consider that the law should uphold property rights for depositors as much as for other asset-holders.”
And if depositors are aware that the bank utilises fractional reserves? Rothbard wanted to make it illegal, so reducing the freedom of depositors. And, of course, making illegal centuries of evolved market practice and the modern banking system. How ironic…
“steven keen’s empirical “proof” would be dismissed by market operators, whose job it is to parse and analyse every word uttered by the board members of the central bank, much in the way of the kremlinologists of yore.”
Yes, I know that “Austrians” dislike empirical evidence — it exposes flaws in the great chains of deductive reasoning they so love. Hence Mises:
“If a contradiction appears between a theory and experience, we must always assume that a condition pre-supposed by the theory was not present, or else there is some error in our observation. The disagreement between the theory and the facts of experience frequently forces us to think through the problems of the theory again. But so long as a rethinking of the theory uncovers no errors in our thinking, we are not entitled to doubt its truth”
Still, the awkward fact is that central banks do not control the money supply nor force banks to issue credit. And, I wonder, where are all the 100% reserve banks? After all, there must be a market niche out there for all the depositors seeking it — a market niche which has never been exploited as long as banks have existed…
Which is the key flaw in the whole “Austrian” theory — the state does not force banks to issue credit. The banks do so for profit-seeking reasons. No bank has ever been forced not to have 100% reserves, but they act that way. Why? Because they are capitalists!
Having a business cycle theory rooted in equilibrium and premised on abolishing banks as capitalist businesses by regulating their activities seems somewhat ironic from a school of economics which pays so much lip-service to “disequilibrium” and opposition to state regulation of profit-seeking entrepreneurs…
“i’m not familiar with hayek’s exchanges with sraffa regarding the trade cycle”
That you are unaware of it confirms my point that the “Austrians” do not like to mention Sraffa or Kaldor. Perhaps you should look into the exchanges of the 1930s, after all Sraffa forced Hayek to admit his position was rooted in equilibrium and so at odds with reality. Kaldor made Hayek rewrite his theory twice…
that’s correct reason, but there is nothing to suggest to the real estate agent that the boom isn’t going to last enough time to pay for the kids’ private schooling. even those who saw the bubble for what it was didn’t have a precise idea of when the party was to end. it was just a case of making hay whilst the sun shone. that’s perfectly rational.
i’m not talking about new industries with adoption delays, but existing industries that have attracted more entrants than they otherwise would have.
Lord #96
I think have reposted, yes, but you must agree that the comment was in general of very poor quality, so bad in fact that it looked to me like a case of Poe’s law.
Oh, I should also mention that the original post was a wee bit misleading as regards Marx. He was well aware of the effects of credit expansion — long before Mises put pen to paper. He just correctly recognised that this was built on an underlying cycle which was rooted in the contradictions of capitalism.
Marx did not assume that money is neutral and he had explained the role of credit expansion in the business cycle (the Mises-Hayek theory) long before Mises put pen to paper. To quote a passage of Marx’s in Doug Henwood’s excellent Wall Street:
“[Credit is] the principal lever of overproduction and excessive speculation… because the reproduction process, which is elastic by nature, is now forced to its most extreme limit; and this is because a great part of the social capital is applied by those who are not its owners, and who therefore proceed quite unlike owners who, when they function themselves, anxiously weigh the limits of their private capital. This only goes to show how the valorization of capital founded on the antithetical character of capitalist production permits actual free development only up to a certain point, which is constantly broken through by the credit system. The credit system hence accelerates the material development of the productive forces and the creation of the world market, which it is the historical task of the capitalist mode of production to bring to a certain level of development, as material foundations for new forms of production. At the same time, credit accelerates the violent outbreaks of this contradiction, crises, and with these the elements of dissolution of the old mode of production…. The credit system has a dual character immanent in it: on the one hand it develops the motive of capitalist production, enrichment by the exploitation of others’ labour, into the purest and most colossal system of gambling and swindling, and restricts ever more the already small number of the exploiters of social wealth; on the other hand however it constitutes the form of transition towards a new mode of production. It is this dual character that gives the principal spokesmen for credit, from Law through to Isaac Péreire, their nicely mixed character of swindler and prophet.”
Volume 3 of Capital does into credit in some detail, noting how it impacts on the business cycle (although not creating it). As such, the “Austrians” simply repeated Marx’s analysis but added elements (such as equilibrium, time-preference, the “natural rate” of interest, love of capitalism and so forth) which Marx rightly rejected.
See also Crotty’s 1985 paper The Centrality of Money, Credit, and Financial Intermediation in Marx’s Crisis Theory: An Interpretation of Marx’s Methodology (pdf) or Steve Keen’s excellent The Minsky Thesis: Keynesian or Marxian (pdf).
Oops
That should read
Lord #96,
I have already responded, yes agreed, BUT you must agree that the comment was ….
to anarcho:
yes, i’ll do some homework on sraffa, but don’t confuse my ignorance on this point with the austrian camp at large.
of course commercial banks lend for profit, but the short end of the yield curve is controlled by the central bank. so the pricing is off a central bank parameter.
those who like the rothbardian fully-reserved banks do so because the see the frb system as an abuse of property titles, ie fraudulent in a moral sense. why are there no 100% reserve banks? you already know – because banks get to make more money, and when they get into strife, they get a helping hand from the state.
as far as empiricism, austrians don’t blindly try to analyse facts hoping to stumble across theory, they logically deduct the theory first, and then see whether there’s any factual evidence afterwards.
newson,
It doesn’t take much specific human capital investment to become a real estate agent. Lying and being aware of prices is a generalised sales skill.
newson
“as far as empiricism, austrians don’t blindly try to analyse facts hoping to stumble across theory, they logically deduct the theory first, and then see whether there’s any factual evidence afterwards.”
And if their theory is wrong?? Every theory is a simplified abstraction, based on a pre-selection of assumptions. How do you know which assumptions are empirically relevant?
This seems to me to reverse the normal scientific process, which starts from observations requiring explaination.
newson
“i’m not talking about new industries with adoption delays, but existing industries that have attracted more entrants than they otherwise would have.”
So you missed my point. Why do you think (assume) that monetary policy is the main source of the problem?
reason:
economics is not able to be dealt with like the natural sciences…too many variables, and no constants. and don’t be too certain that a real-estate salesman requires no skill, nor to be a plasma-screen tech. spivs are people, too.
as to why monetary policy is the main source of the problem – well, there’s no part of the economy that is not affected by the interest rate, whether it is as a borrower or a lender. change that rate, and you change all sorts of decisions. why do you think the central bank alters the discount rate if not to produce certain effects? (that they fail in their intent is a different matter).
newson…
Have you read “Zen and the Art of Motorcycle Maintenance”?
In it, he notices that for any observed phenomenon there are a very large number of plausable explainations. Science tries to weed these out by making predictions from the hypotheses available and finding OTHER facts to test them with. It is an iterative, evolutionary process. Where is the iteration and evolution in the Austrian approach?
What makes me very suspicious of “Austrian” enthusiasts is that keep going back to the “Holy Scriptures” from von Mises or Hayek to find out what the prophets said, in said of looking for real world evidence to support their contentions.
reason, apart from “big brother”, no lab experiments are possible on human beings. now i like broccoli, tomorrow i don’t – no constants. natural science relies on constants.
and now i’ve got to be off to work. thanks to all for a good debate. and, the winner is clearly…intellectual curiosity.
newson…
and what determines the interest rates that real people deal with (as against those set by the Central Bank)? What do you think a central banker is trying to do exactly?
I’ll tell you what I think he is trying to do. He is trying to change expectations of the future slightly. He is signalling to people that he will keep the future price level as predictable as he can – and it is mainly expectations of future price levels that effect the long end of the curve. The short end of the curve mainly effects the incentive for banks to lend.
That is why I would like the talk of “Austrians” to be more specific when they talk about “interest rates”. Which interest rates exactly, and do they mean real interest rates or nominal interest rates. (There is a good argument that says that central banks change their nominal interest rate to try to keep real interest rates more stable). Interest rates ARE set by the market not the central bank, the central bank is mostly about signalling.
And I would also like more discussion of the importance of the exchange rate in all this. My reading of the crisis was the real source of the problem was neo-mercantilism, the US financial instability was an endogenous response to this. I tend to think of monetary policy targeting inflation and the exchange rate targeting full employment. If the exchange rate is distorted, it tends to distort monetary policy.
I think I should explain my last comment more. Hoarding of money, ceterus parabus, tends to result in deflation. Deflation + debt = collapse. The central bank in US created more debt in order to stop deflation and collapse. So I agree with the Austrians, the problem would not have got so bad if there wasn’t a Central bank, we would have had a (smaller?) collapse earlier. But it is not clear how the recovery would then start, unless the core problem of neo-mercantilism (and the resultant drain from the circular flow of funds) was removed.
My solution would be to replace debt money with base money – keep printing money until the neo-mercantist yell “enough” and the USD lost its reserve status.
We shouldn’t be putting up with persistant large balance of payments imbalances, eventually balance sheets must crack somewhere. It is not that there are too many controls, one control that should exist is clearly missing.
P.S.
Please note that deflationary collapse rewards the hoarders who are the primary source of the problem. This is what happened with the gold standard as well. Hoarders need to pay a price for hoarding rather than be rewarded for it, which is what Keynes argued in the 1930s but got blocked by the Americans. Monbiot wrote a good column on it in the Guardian.