Distributional Effects of Monetary Policy: An Opportunity for Austrian Economics

by Sebastian Müller

For a long time, Austrian macro had a unique selling point in what might be called the ‘money matters’ view: referring to the notion that changes in the money supply by their very nature can never be said to be neutral. Yeager (1997) and Horwitz (2000) describe the Austrian stance as a “fluttering veil”. On the one hand, it incorporates the belief that prosperity cannot be generated through an expansion of the money supply in the long-run (long-run neutrality of money). On the other hand, changes in the money supply have real effects (short-run non-neutrality).

This proposition can be traced back to the works of classical economists such as Hume (1970), Mill (1909), Cairnes (1873), and Cantillon (1755).[i] In his essay on economic theory, Cantillon (1755) points out that an expansion of the money supply necessarily entails distributional effects as first receivers of the newly created money benefit compared to those ones further down the line.

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The Irrelevance of Deposit Creation for Prices and Allocation: Comments on Selgin

by Arash Molavi Vasséi

In a previous post, Andreas refers to George Selgin’s recent discussion of the place of fractional reserve banking in the Austrian Business Cycle Theory (ABCT). There, Selgin takes a swipe at the monetary pillar of the ABCT. According to the Austrian model, fractional reserve banking is inclined to create money out of “thin air” and, therewith, admits investment spending in excess of “voluntary saving”. This imbalance, allegedly induced by a decline in reserve ratios, is reflected in a Wicksellian interest rate gap, which is supposed to impact prices and the allocation in a systematic way (the real pillar of the ABCT). Selgin argues that fractional reserve banking does not account for the Austrian business cycle, and Andreas expresses sympathy for this view.

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Selgin on Money Creation

by Andreas Hoffmann

George Selgin has a much-discussed post over at Alt-M. I agree with most of it.  However, I am puzzled by the following statement:

Austrian accounts of the money-creation process often exaggerate the ability of fractional reserve banks to create money “out of thin air,” even while sticking to a fixed reserve ratio, by looking at only one part of the bank money creation process.

[…]

Actually, it isn’t, for the simple reason that, more often than not, a deposit made at one bank involves a corresponding withdrawal of funds from another bank, as when the deposited sum takes the form of a check.

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Friedrich von Wieser, or: Against “Sidelining” Austrian Economists

by Stefan Kolev

Historians of economics must resist the temptation to put their narratives into the service of ideology. The intriguing case of Friedrich von Wieser exemplifies the grave dangers involved for history of economics as a discipline and for Austrian economics as a respectable research program – but it also provides hints on how to immunize historical accounts from the dangers of hagiography and litmus-test purity checks.

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Hayek’s Work Helps Explain the Link between Ultra-loose Monetary Policy and Political Instability

by Gunther Schnabl

The European Central Bank will increase the overall volume of its bond purchase program to 2,550,000,000,000 euros by September 2018. The main refinancing rate will remain at zero. Mario Draghi has stressed that this policy shall continue until inflation picks up sustainably (which is unlikely to happen in the foreseeable future). The works of Friedrich August von Hayek (1931, 1944, 1976) help to explain why the tremendous monetary expansion is increasingly causing growing economic and political instability in Europe.

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Should Central Banks Lean Against the Wind?

by Andreas Hoffmann

The pre-crisis Jackson Hole Consensus view on how to take asset market developments into account in monetary policy can be summarized as follows: Because it is hard to spot bubbles in asset markets with certainty ex-ante, central bankers should not lean against the wind when there seems to be a boom in financial markets (as long as the inflation rate does not pick up). However, as a rapid fall in asset prices can pull the real economy into the maelstrom of crisis, monetary policy should react decisively when a bubble bursts and “clean up the mess” to  prevent spillovers to the real economy.

Because there is empirical evidence that countries with greater credit and asset market booms in the 2000s experienced more severe financial crises in 2007-9, the pre-crisis consensus view has lost popularity. Policymakers and academics have started to think of ways to curb financial booms and lower the probability of crisis using macroprudential regulation or leaning-against-the-wind monetary policy. Continue reading

The Viennese culture of conversation: Understanding and defending fragile orders

by Stefan Kolev*

For a better understanding of the turbulences of our time, studying those earlier politico-economic debates which focused on fragile orders of economy and society can certainly prove insightful. In The Viennese Students of Civilization, Erwin Dekker addresses such an age and interprets the works and impact of economists often labeled as the “Austrian School” – economists who are both the research object for historians of economics and the source of inspiration for today’s “Austrian Economists”. Continue reading

Call for Papers: 2017 SDAE Meetings (Deadline: April 1, 2017)

The annual meeting of the Society for the Development of Austrian Economics will be held during the Southern Economics Association meetings in Tampa, FL at the Tampa Marriott Waterside Hotel and Marina, November 17-19, 2017 (Friday to Sunday; more information can be found here: https://www.southerneconomic.org/conference/).

Members interested in presenting papers, serving as chairs/discussants, or proposing entire panels should submit proposals by Saturday, April 1, 2017. Continue reading

Discussion of Israel Kirzner’s Work on Entrepreneurship

Check this out at Liberty Matters.

Lead Essay: Peter J. Boettke, “Israel M. Kirzner on Competitive Behavior, Industrial Structure, and the Entrepreneurial Market Process” [Posted: March 1, 2017]

Responses and Critiques

Mario J. Rizzo, “Kirzner’s Theory of the Market Process” [Posted: March 6, 2017]
Peter G. Klein, “Entrepreneurial Discovery: Who Needs It?” [Posted: March 8, 2017]
Frederic Sautet, “Purposeful Human Action and Entrepreneurship: Kirzner’s Misesian Contribution” [Posted: March 9, 2017]

Interview with Gerald O’Driscoll

by Mario Rizzo

I am happy to post a very interesting interview with my long-time friend and Cato senior fellow, Jerry O’Driscoll. As readers of ThinkMarkets know, Jerry frequently contributes to this blog. This is from the Lara-Murphy Report. The entire report can be accessed immediately below. The interview with O’Driscoll begins at page 24.

LMR Interview with Odriscoll

O'Driscoll Interview
O’Driscoll Interview
First Page of Interview
First Page of Interview

Herbert Davenport: The Economics of Enterprise

Economics of EnterpriseHerbert davenport

by Richard M. Ebeling*

This year marks the hundredth anniversary of the publication of Herbert J. Davenport’s (1861-1931), The Economics of Enterprise, which appeared in the early months of 1913.

Both mainstream economists as well as many “Austrians” seem to have long since forgotten Herbert Davenport. But during his time he was recognized as one of the early formulators of a subjectivist conception of opportunity cost, a harsh critic of Alfred Marshall’s attempt to partly preserve the “real cost” doctrine of the Classical Economists, and a lucid expositor of the central role of the entrepreneur in a dynamic vision of the market process.

His earlier article, “Proposed Modifications in Austrian Theory and Terminology” (Quarterly Journal of Economics, May 1902), and his book, Value and Distribution (1908) were “friendly criticisms” meant to clarify inconsistencies or ambiguities in the “Austrian” approach with which he was, in general, highly sympathetic.

Born in Vermont, he earned a PhD in economics under J. Laurence Laughlin (a strong defender of laissez-faire economics) at the University of Chicago, but was also influenced by (though critical of) Thorsten Veblen. For many years he served as the Dean and Department Chair of the College of Business at the University of Missouri. He later served as a professor of economics at Cornell University.

According to Paul Homan, he was a captivating classroom professor: “One remembers him most vividly and typically leaning back in his chair, his penetrating eyes touched with the shadow of a smile, as of triumph, while he deployed his arguments, humorously but with devastating order and precision, usually at the expense of someone, preferably Marshall, whom other people took seriously and whom he regarded as hopelessly muddle-headed.”

The Economics of Enterprise presents his full analysis of the market order in terms of subjectivism, causality, and entrepreneurial competitiveness. Continue reading

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:   Continue reading

A “Kleinian” Version of Austrian Business Cycle Theory

by Gene Callahan

The next phase in my (now our, as I’ve taken on a colleague) project of thinking through Dan Klein’s Knowledge and Coordination is to see how his ideas might be used to help describe business cycle theories and demonstrate commonalities they share. Note: the point of the present exercise is simply to try to describe an existing business cycle theory in Kleinian terms, not to improve upon it or argue for its accuracy.

We will begin with the Austrian Theory of the Business Cycle: Continue reading

Fads as Social Cycles

We don’t follow fashion
That would be a joke
You know we’re going to set them set them
So everyone can take note take note — Adam Ant and Marco Pirroni

by Gene Callahan*

In his book Knowledge and Coordination, Daniel Klein distinguishes between mutual coordination and concatenate coordination. Mutual coordination is coordination which people intend: you and I plan to meet for lunch, or several con artists devise a scheme to defraud an elderly widow of her fortune. Concatenate coordination is coordination that is pleasing to an impartial observer: one of Klein’s examples is a room designed with a harmonious combination of colors, shapes, and so on.

It is important to note that successful mutual coordination does not imply concatenate coordination. If the con artists pull off their scheme to defraud the widow, they will have achieved mutual coordinaiton that is not concatenate coordination. (I really cannot do this schema full justice here; I am just introducing it to make sense of the rest of this post, and you really must read the book to fully grasp it.)

Let us analyze fads using Klein’s terms. Continue reading

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). Continue reading

Notes on a General Theory of the Social Cycle

by Gene Callahan

Monday past at our colloquium Andreas Hoffman presented a fascinating paper attempting to depict Austrian Business Cycle Theory as a special case of a more general business cycle theory based upon Hayek’s later work on spontaneous orders. Hoffman’s general idea (I won’t do it justice in this brief summary, so please have a look at the paper) is that business cycles occur when a “displacement” creates a situation in which people are uncertain how to make “adjustments” to move back closer to equilibrium. The period during which people are groping about for what to do creates the slump, and the upturn comes, of course, once they have gotten the hang of the new situation.

A lively discussion followed, during which Israel Kirzner, Mario Rizzo, and others pressured Hoffman on just what he meant by an “adjustment,” a “displacement,” and why these things would create a cycle, rather than merely ongoing “churning,” to use Kirzner’s word. (He also mentioned Lachmann’s notion of the “kaleidic society” in this context.)

Riding home on the subway afterwards, what struck me was that we lacked a general framework of accepted definitions for talking about things like adjustments, displacements, and social cycles. (I will justify the use of “social” later.) As soon as I noticed this, the following thoughts entered my mind, essentially all at once. Some of them were drawn directly from the discussion. And they are all very preliminary: but that is one thing that blogs are for, is it not? In any case, feedback on these presently sketchy ideas is welcomed. Continue reading

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.

Yes, Paul: It is Hayek versus Keynes

by Mario Rizzo

Although by the standards of contemporary economics, I am a historian of economic thought, I am not a historian of economic thought, properly considered. Thus my major interest in F.A. Hayek’s business cycle theory is not from the point of view of a historian. My interest is only incidentally in how Hayek’s contributions were perceived in the 1930s and 1940s, especially in light of John Maynard Keynes’s Treatise on Money and General Theory.

I am interested in Hayek’s business cycle theory because I believe it has much to teach us today – both in the style of reasoning it embodies and for its substantive points. Of course this is not to say that Hayek’s approach cannot be improved upon and revised in light of more recent theoretical and empirical developments.

But now comes Paul Krugman with his sometimes-echo Brad Delong (or is it vice versa?). Krugman thinks that Hayek was not an important “macro” economist; certainly not the rival or alternative to Keynes, either in the 1930s or today.  Continue reading

Radical Ignorance in the Financial Crisis

by Sandy Ikeda

Jeffrey Friedman and Wladimir Kraus have a new book out, Engineering the Financial Crisis, (Univ. Penn Press) that grew out of research that first appeared in Critical Review back in 2009 on the “Causes of the Crisis.”  Friedman’s lead article in that issue did an excellent job of providing a detailed but readable description of the institutional setting of the crisis and an account of the complex events, domestic and international, that led to it.  I’ve only skimmed the book, but it appears offer a similar kind of useful description and analysis of these and many other events surrounding the crisis.

What distinguishes this book, and what may be of particular interest to readers of this blog, is it’s explicitly Austrian perspective on the role of ignorance, in the private but especially the public sector, as the analytical starting point of the crisis.

The meta-mistake that economists make in ignoring ignorance (or in reducing it to “rational” or deliberate ignorance or to “asymmetric information,” where one party does know the truth) is suggestive, we think, of the problems that modern democracy faces:  If economists are our most important advisers, but their worldviews have no place for genuine human error, we are in deep trouble (151).

A rationalist constructivist hubris led public authorities to create a “hybrid capitalism” that incited entrepreneurs to ever riskier investments, the consequences of which no one could foresee though they perhaps might have imagined.  The book’s title Engineering the Financial Crisis captures that idea well.

Chicago and Vienna

by Jerry O’Driscoll

In the last two days, two prominent economists have asked me essentially the same question: what is the difference between Chicago and Austrian economics? It is interesting that both asked, particularly since one has a Ph.D from Chicago.

The second economist asked me specifically if Armen Alchian wasn’t really an Austrian. I’ll respond as I did to him. I learned most of my Austrian economics in the UCLA graduate economics program. (At that time, UCLA was known as Chicago West.) I was never an Alchian student, but one read lots of Alchian anyway. And his influence pervaded the department. It was obvious to me that Mises had influenced Alchian. Also Hayek, as is made clear in a video of Alchian interviewing Hayek.

Hayek’s classic essays on prices and information were on various reading lists at UCLA. Continue reading