James M. Buchanan: A Preliminary Appreciation

by Mario Rizzo

The great economist James M. Buchanan died today at 93. I am still too stunned to write a proper appreciation of his tremendous contributions to economics and, indeed, to moral philosophy.

Buchanan won the Nobel prize in Economics in 1986. But even this does not capture his greatness. There have been many Nobel prizes in Economics since 1969, the year they were initiated. (In my view there have been too many.) Many of these prize winners will be long forgotten and even viewed with puzzlement by future generations, but this prize will stand out.

Clarifications of the Austro-Wicksellian Business Cycle Theory

by Mario Rizzo

There has been a lively debate on forecasts of high inflation made by those worried about the Fed’s recent policy of quantitative easing. For details I refer the reader to Daniel Kuehn’s excellent blog. The question to which I address myself is solely “What do these predictions have to do with core Austrian Business Cycle Theory?” This is my answer.

We must start with a few general points. First, I am talking about the Austro-Wicksellian business cycle theory as developed by Friedrich Hayek and Ludwig von Mises and as synthesized by Roger Garrison in his book Time and Money. I cannot take responsibility for versions constructed by others.  It is not that I think the others are necessarily wrong (and I mean no disrespect to them), but I do not know with sufficient precision what all these others are saying in the name of “Austrian theory.”

Secondly, the Austro-Wicksellian theory begins with either an endogenous increase in credit through the banking system or with an “exogenous” increase initiated by a central bank. In the latter case, however, the theory itself has little to say about the extent to which increases in base money will manifest themselves in increases in bank credit to producers.  (This may not be much of an issue during a boom but may be an issue during a recession or in a recovery.)

Third, the theory is fundamentally one about the “upper turning point” in the cycle – it is a theory about why a credit-induced boom must come to an end. It is not a theory, for better or worse, about the “secondary” factors that develop consequent on the break-up of the boom. These include possible recessionary-problems relating to bank runs (there is an Austrian inspired banking literature, but that is not the cycle theory) or what exactly will get investment expectations to turn around.  As to deflation, Lawrence White has argued that the logic of the theory requires the avoidance of deflation in accordance with Hayek’s very early recommendation to keep M V from falling.  (Hayek departed from this in the Depression, and later admitted he was incorrect to do so.)

Now to more specific points:  

“Modern Market” Monetarism?

by Mario Rizzo

Douglas Irwin, a very fine economist at Dartmouth College, has a very puzzling opinion piece in yesterday’s Financial Times. The root of the puzzle is that Irwin seems to accept what I consider the naïve monetarist view, yet calling it by a new name “market monetarism,” that the effectiveness of monetary policy largely revolves around portfolio adjustment effects that are induced by an increase in real balances. (Isn’t this warmed over Pigou, and 1970s monetarism?)

What seems to be new is the “Divisa monetary indexes” which weight the different components of the monetary aggregates by their monetary services. In principle, this is what Milton Friedman talked about in his course ”Money: The Demand Side” in the early 1970s. He said then that he thought it would be a good idea to weight the various components of the money supply by their “degrees of moneyness.” He did wonder, as I recall, if these weights would be stable over time.

Now, by this new measure, monetary policy has been tight. In fact, the money supply is no higher today than in early 2008.

Wisconsin Policy Lab

by Chidem Kurdas

Paul Ryan is said to be influenced by Milton Friedman, Friedrich von Hayek and Ayn Rand. One might add that as the representative for Wisconsin’s first congressional district, he is from a state that has often been in the vanguard of policy thinking.

The Limits of Bayesian Inference

by Gene Callahan

Dan Klein’s Knowledge and Coordination has something interesting to say about Bayesian inference, although he never explicitly addresses that topic. Consider the following:

Here, we have the distinction between responding to the realization of events within a framework of recognized variables and relationships and the discovery of a fresh opportunity to embrace a new and better framework or interpretation. This element of epiphany, of finding fortune by interpreting the world differently, is the subtle and vital element in human decision making. Yet, it is absent from equilibrium model building. In equilibrium stories, agents never have a “light bulb” moment… (p. 13)

Kirzner’s alertness is the individual’s re-interpretation of that world [of a world of already-interpreted "facts"]. (p. 14)

“Equilibrium” is meaningful only in reference to a specified model… (p. 28)

Bayesian inference, similar to equilibrium theorizing, works within a fixed frame of interpretation: it “is meaningful only in reference to a specified model.” It cannot extend across instances when a new interpretive framework takes the place of the old.

Austrian Economics: An Empirical and Experimental Science

by Mario Rizzo

I have been doing research on the ideas of the first-generation Austrian economists (Menger, Wieser and Boehm-Bawerk) as they relate to contemporary developments in behavioral and experimental economics. I have come upon a number of interesting things. I expect to share some of them here as well as in a soon-forthcoming paper. Today I wish to share this quotation from Friedrich von Wieser. These sentences are the opening words of an article commissioned by the Economic Journal to explain the ideas of the Austrian school to English-speaking economists:

“The historical school of political economists in Germany, and the Austrian, or as it is frequently termed, the abstract school are more nearly related than is at first sight apparent. Both follow the spirit of the age in rejecting speculative theory and in seeking their highest laurels in the field of observation. In art, as in science, naturalism must be distinguished from truth to nature, and we Austrians, while we have certainly no wish to be disciples of naturalism, we are wholly set on being experimentalists.”

Friedrich von Wieser, “The Austrian School and the Theory of Value,” Economic Journal (March,1891).

HAPPY BIRTHDAY, PROFESSOR HAYEK

by Mario Rizzo

I could not let May 8th pass without writing something about F.A. Hayek, or rather my appreciation of Hayek. I have not been blogging recently because I have been working very hard researching and, at last, writing my book, with Glen Whitman, on behavioral economics and the new paternalism (no real title yet).

In terms of my own thought, Hayek has been the most influential economist I have have ever encountered. I met him several times — going back to 1968 or thereabouts — but I never really knew him. He seemed difficult to get to know and even to talk to, though he was generally kind and open after he won the Nobel prize. (Before that I found him very distant and not much interested in us young’ins.)

Hayek helped me appreciate Ludwig von Mises who was rarely convincing to me.  While Mises made many a grand assertion Hayek provided careful and subtle arguments. The often arrived at the same place but I found (find) Hayek more persuasive. I also preferred his softer style.

I think the most important insight of Hayek was to understand that knowledge in any large society is decentralized. The most important function of social institutions is to mobilize this knowledge in such a way that it can been used by individuals in making their decisions. Thus: the impossibility of rational calculation under socialism (a conclusion Mises came to in a somewhat different way), the importance of the rule of law, the importance of cultural-social rules, and so forth. Compare that with, in my view, the misguided trivality of Paul Samuelson’s behaviorist theory of revealed preference or Richard Kahn’s mechanical multiplier or Maynard Keynes’s contributions to economic policy guided by his elite hand. I could go on.

In just about every class I teach I tell students about the meaning and the significance of Hayek’s idea of the decentralization of knowledge in society. This idea alone has the power to change minds dramatically. One student told me it changed her life. I do not care if students remember the Weak or Strong Axiom of Revealed Preference or the necessary conditions for perfect competition if they remember Hayek’s ”The Use of Knowlege in Society.”

DeLong, Friedman and Maximal Government

by Chidem Kurdas

The case made for minimal government by Milton and Rose Friedman in their 1979 book, Free to Choose, has been debunked,  according to Berkeley professor Brad DeLong.  Basically, he avers that the Friedman program has been tried and failed. As a commentary on Friedman, this is outrageously misleading. But Mr. DeLong  provides a revealing glimpse of the left-liberal mindset.

O’Driscoll and Rizzo Got There First

by Gene Callahan

I had believed that Tony Carilli and Greg Dempster (“Expectations in Austrian Business Cycle Theory: An Application of the Prisoner’s Dilemma,” The Review of Austrian Economics, 2001) made a major advance in Austrian Business Cycle Theory by hitting upon the correct solution to the challenge presented by, for instance, Gordon Tullock, who once wrote:

“The second nit has to do with Rothbard’s apparent belief that business people never learn. One would think that business people might be misled in the first couple of runs of the [Austrian] cycle and not anticipate that the low interest rate will later be raised. That they would continue unable to figure this out, however, seems unlikely.” (“Why the Austrians Are Wrong about Depressions”)

By posing the situation as a prisoner’s dilemma, where businessmen are rational to exploit the short-term profit opportunities offered by the boom phase (since if they don’t their competitors will) Carilli and Dempster adequately answered Tullock’s complaint. (I especially liked their solution because I independently had hit upon the same idea, which I was working out while writing my book, Economics for Real People. Well, I wasn’t the first to print, but at least I was the first to reference their paper!)

But yesterday, while editing someone else’s work, I discovered that Gerald O’Driscoll and Mario beat us to the basic insight by several decades, although they did not give it a game-theoretical formulation:

“[T]here are profits to be made from exploiting temporary situations. . . . Though entrepreneurs understand [the macro-aspects of a cycle] they cannot predict the exact features of the next cyclical expansion and contraction. . . . They lack the ability to make micro-predictions, even though they can predict the general sequence of events that will occur. These entrepreneurs have no reason to foreswear the temporary profits to be garnered in an inflationary episode. . . . From an individual perspective, then, an entrepreneur fully informed of the Austrian theory of economic cycles will face essentially the same uncertain world he always faced. Not theoretical or abstract knowledge, but knowledge of the circumstances of time and place is the source of profits.” O’Driscoll and Rizzo, The Economics of Time and Ignorance

Note: I still think what Carilli and Dempster did, in giving this a game-theoretic formulation, is great work. I just see it is not quite as original as I had thought.

M. Friedman Goes to Washington

by Chidem Kurdas

Early in his career, long before he became a Nobel prizewinner and the household name for free market economist, Milton Friedman worked for the US Treasury. The following anecdote is from his 1998 memoir with his wife Rose, Two Lucky People.  This revealing example of how public officials operate illustrates, in Friedman’s words, “the interaction between bureaucratic self-seeking and supposedly objective analysis.”  It complements my previous post on whether politicians pursue the public good.

World War II had started. For Friedman and others at the Treasury, the main mission was to figure out how to finance the war effort while avoiding inflation.