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:  

Bo as Emblem of State Capitalism

by Chidem Kurdas

The fallen Chinese political chieftain Bo Xilai and his wife are starting to sound like a bizarre combination of Macbeth and his Lady, the US Department of Housing and Urban Development and Fannie Mae—yes, the government created and backed housing finance entity.

Under the leadership of the Mao-admiring “new left” Mr. Bo, the fast-growing city of Chongqing built extensive public housing. Apparently the local government  created investment vehicles to finance its various projects, issuing bonds with land as collateral. The WSJ reports that analysts regard this debt as increasingly risky. 

What Is Old Can Be New

by Mario Rizzo

This is the unedited version of my letter which appears in today’s (August 9th) Wall Street Journal. The first sentence was edited out. Too bad. 

————

There is a lot of discussion of the need for “new economic thinking” these days. Henry Kaufman (“Excessive Optimism and Other Economic Biases,” August 2nd) correctly criticizes many economists for underestimating the importance of structural changes in economic behavior and overestimating the capacity of economics to forecast.  

But sometimes the “old” is really the new. Echoing an older skeptical tradition in economics, the Austrian economist Ludwig von Mises said in 1949,” The fundamental deficiency implied in every quantitative approach to economic problems consists in the neglect of the fact that there are no constant relations between what are called economic dimensions. There is neither constancy nor continuity in the valuations and in the formation of exchange ratos between various commodities. Every new datum brings about a reshuffling of the whole price structure.”  

In a sense, it was the the “new” that misled us.

The Role of the Perverse Elasticity of Credit Money

by Andreas Hoffmann

I want to bring a recent comment by Sornette and von der Backe to the attention of the reader (in Nature 471, p. 166, May 2011). Sornette and von der Backe remind us to pay more attention to disequilibria caused by the fractional reserve banking system to explain the emergence of crises. They particularly recommend a reconsideration of the Austrian School of Economics to derive short-term policy solutions. “We should relearn and expand some of the old economic wisdom about the specific role of banks.”

Ludwig von Mises and His Grand Tautology

by Mario Rizzo

There is a tradition of thought in economics that views the rationality of individual actions as non-falsifiable. There are variations in how this tradition might be justified. These do not concern us to any significant degree here.  For concreteness I shall examine the position of Ludwig von Mises (excerpted below) because of the purity and clarity of his argument.  

Economists want to abstract from any particular theory of human motivation. In particular, in the early years of the twentieth century, they were keen to distinguish between the subjective theory of value and hedonistic (pleasure-pain) theories associated with Bentham and later W.S. Jevons and F. Y. Edgeworth. So they wanted to say that people choose according to whatever standard they might consider important or on whatever deep basis psychologists might discover. This is not the concern of economists (or so Mises and others argued).

Therefore, when economists speak of people seeking to increase their well-being they mean that they do so in terms of whatever they consider important – pleasure, moral values, long-term interests, short-term fancy, and so forth. Economists also did not want to take a position on how carefully individuals choose what goals they want to attain. Thus, an individual increases his well-being, as he sees it, when he drinks away his paycheck as when he spends it on supporting his family.  

What Austrian Economics IS and What It Is NOT

by Steve Horwitz*

Since the start of the financial crisis and recession, there has been a renewed interest in the ideas of Austrian economics by scholars, public intellectuals, and even the media.  For the first time in a long time, the analytical framework of Austrian economics is being taken note of, if not taken seriously, by a variety of opinion makers.  This is, of course, a good development.

However, at the same time, this popularity has led to many people using the “Austrian” label to refer to their views on issues beyond those involving the analytical framework they bring to economics.  In particular, “Austrian” has become the near-equivalent of “free market” or “libertarian” not only indirectly, but directly through the use of terms such as “Austro-libertarian” to describe particular policy preferences or broader worldviews.  The result is that, despite the additional publicity, what Austrian economics IS has often been distorted into something it is NOT.

Happy Birthday to Ludwig von Mises

by Mario Rizzo

Today is the birthday of the great Austrian economist Ludwig von Mises (1881 – 1973). For a brief appreciation, I refer the reader to my comments of a year ago.

The Man as a Boy

Austro-Wicksellian Theory of the Business Cycle: An Informed View

by Mario Rizzo

There has been recent discussion in the blogosphere of the so-called Austrian Business Cycle Theory (ABCT). (We must not forget to give the Swedish economist Knut Wicksell credit as well.) Some of it is interesting (mostly because of the comments) but much of it is ill-informed since the bloggers don’t like to read scholarly Austrian work. For a good blog post with references to what others have been saying, see Pete Boettke’s discussion at Coordination Problem.

The first thing to keep in mind is that while this theory embodies “Austrian” characteristics it is not an official Austrian theory.

Methodological Individualism Reconsidered

by Gene Callahan

Many Austrian economists embrace the doctrine of ‘methodological individualism,’ as I myself did, for instance, in my book Economics for Real People. But subsequent study on my part, most significantly of the work of Tony Lawson in his philosophy of economics project he calls ‘Critical Realism,’ as well as my readings of the social theories of the British Idealists, has led me to question the soundness of that position.

I will begin by noting that I think the adoption, by Mises, Hayek, and other Austrians of their era, of methodological individualism is understandable, given that the chief alternatives available when they wrote were some sort of ‘social holism,’ a la Durkheim, or Marxist historical and class determinism. If one’s choice is restricted to those three options, I believe methodological individualism is indeed the preferable stance to take.

Pigou is the new Keynes

by Sandy Ikeda

A full-page article in today’s Wall Street Jounal begins:

At the Heavenly Models home for deceased economists, an award is being presented to the resident whose work best explains financial crises, global warming, and other pressing issues of today.

The winner, according to author John Cassidy, is A.C. Pigou, the new flavor of the day.

The article implies that Pigou was the first to articulate the concepts of externalities and market failure.  I’m not sure that’s right, though I haven’t gotten around to reading The Economics of Welfare, but I believe we do have to credit him with the Pigou tax.  So in some ways he’s been almost as dangerous as his “smarter colleague,” although I’ve always felt sympathy for someone who was so much in Keynes’s shadow.

The article also has a sidebar quoting Mises (as well as Friedman, Kindleberger, and of course Keynes) apparently calling last year’s economic crisis.