One of those academics that Bush didn't want to listen to

Jeff Miron provides some needed perspective.

On the other hand, on my drive home from Arlington, VA today I was listening on C-Span radio the debate in the Senate.  As you might expect politics and political rhetoric were in full display, but little economics.

Listening to the discussion I wanted to make a post (which I will eventually) emphasizing that economics is not politics and politics is not economics; and political economy is neither public policy analysis nor an art of compromise.  Instead, economics is a science, politics is a subject, and political economy is a branch of moral philosophy.  Just because politicians talk about economics doesn't mean they are making any sense, and just because some economists compromise in political discourse doesn't mean they are doing economics.

A few things to keep in mind during the coming days:

(1) While there may be macroeconomic problems, there are only microeconomic solutions;

(2) Microeconomics is about the structure of incentives and the quality, accuracy of the information (and its interpretation) that economic actors face and utilize in their context of action; The institutions of property, prices and profit/loss provide incentives and information to market participants;

(3) Economic life is a process of constant adaptations and adjustments to changing circumstances, and these adjustments primarily are guided by relative price shifts, the lure of profit, and the penalty of loss;

(4) Inflation is damaging, deflation is damaging --- as Mises once put it, trying to cure the problems created by one by following the other is analogous to someone after driving over a bystander with their car in an effort to try to fix things by backing up over them to undo the damage;

(5) Wealth creation results from realizing the gains from trade and the gains from innovation, not government investment.

If there is no bailout, then the stock market will go down, more financial institutions will fail, and unemployment will rise.  But resources will not go into a black-hole, they will be reallocated and utilized in alternative uses. 

To leave with some words of wisdom from Adam Smith: 

"The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principle that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often incumbers its operations; though the effect of these obstructions is always more or less either to encroach upon its freedom, or to diminish its security." 

BTW, Happy Birthday to Ludwig von Mises.

Comments

[Unit]

I'm not superstitious, but I wonder if the ghost of Mises had anything to do with the vote today...

[Grant]

Rather off-topic, but I'd really love to hear a detailed Austrian perspective of the "bust" phase of a (this?) business cycle, compared to a mainstream explanation. I understand how the reallocation of resources is necissary for recovery (surely every sort of economist must recognize that?), but I rarely hear Austrians talk about the externalities of tightening credit and money supply.

Although, maybe calling credit crunches externalities might be a bit off? Borrowing always has risks, and implicit in taking on any business enterprise which requires credit is accepting the possibility of rising interest rates. Nonetheless, I can't help but feel the many Americans who are going to be unwitting victims of the current crisis will feel these effects as if they were very negative externalities.

Changes in the money supply would seem to be more solid externalities to me? Perhaps not if we had competing currencies, but in our current system...

Too often (to my lay-ears, at least) it seems like Austrians and more mainstream economists are talking past each other. It seems like the Austrians focus on the necissary reallocation of resources in the economy, while everyone else talks about the harmful effects of rising interest rates and deflation (which I would think would harm even firms who would have been existed in the absence of the original monetary inflation).

[Anon]

Me-too!

I would especially be interested in knowing whether the US is likely to be entering a period of deflation or inflation. There seems to be no clarity on this point.

[Peter Boettke]

On the differences among Austrians and the mainstream on monetary policy, read the comments by Richard Ebeling for the history of thought on this matter. The postcard version is that the current policy makers believe we should fear deflation and the cummulative rot that would result in bringing the economy to a halt (an easy reading book in this tradition would be Greenfield's book on the Great Depression), while the Austrians put more of the emphasis on disturbances on the inflation misallocations that need to be corrected during the bust phase. Horwitz's work seeks to combine both an examination of the problems with inflation and a problem with deflation.

I disagree with the point about the cummulative rot for reasons similar to what Miron lays out, and I fear that the various injections of funds into the system will be inflationary.

Pete

[matthew mueller]

I would second Dr. Boettke's comments recommendation. Steve Horwitz has done some excellent work in the area of Austrian inflation-business cycle theory and the monetary disequilibrium deflation-business cycle theory.

http://myslu.stlawu.edu/~shorwitz/Papers/Monetary_JHET_1996.pdf

Horwitz is correct in identifying the differences in outlook between these two approaches in their contrasting views of capital theory. Who said capital theory is an idle pastime of Austrian economics (Leeson)? By the way, I think the BEST critique of Keynes' General Theory has come from Ludwig Lachmann and his extension of Hayekian capital theory to the concept of Keynes' marginal efficiency of capital. What remains to be done is a direct confrontation with the Cambridge (UK) capital theory and its more recent development, endogenous growth theory (Kaldor-Eatwell-Milgate). Lachmann hints at this in one of his essays in the Don Lavoie edited volume, but I still think more work needs to be done in this area.

To Grant, if you want to get a more eclectic view of the Austrian theory of the bust, I would suggest consulting the "secondary depression" literature. For Rothbard, it is simple: Hands off. Let the market tank as far and deep as it can! But others, like Haberler and Ropke, were more careful in noting the difficulties of policy responses to the bust phase of the business cycle. As an introduction, I would suggest reading the essays in Lachmann's "Capital, Expectations, and the Market Process" book that deals with this topic. (Check the index for the pages.) Next I would read the second half of Ropke's "Crises and Cycles" which is available at the Mises Institute website.

And about externalities --- There are none!

(:

[Grant]

Matthew,

Thanks for the help. I don't have the Lachmann book, but I did read quite a bit of Ropke. While I liked some parts of it (especially how he points out the similarities between the "neutral money" and "stable money" schools), but I found Horwitz's paper a lot more helpful.

I actually find it hard to read anything by Rothbard. I already know what he's going to say (government is the problem, nothing should be done, etc, etc), and even when he's right I still prefer intellectual honesty.

"And about externalities --- There are none! "

Can you explain this at all? From where I'm sitting, economic calculation appears to be a public good, which both monetary inflation and deflation distorts. So the initial inflation is bad, but why can't we prevent deflation of the money supply without propping up the malinvestments? Horwitz talks about the dis-coordinating effects of deflation in the paper you linked to. I understand the problem of preventing deflation by altering the interest rate or propping up bad lines of credit, but it seems like something could be done under our current banking system. Dare I say just dropping money from helicopters? ;)

By the way, if anyone is actually reading this, has anyone done anything on ABCT and capital theory which accounts for capital reswitching?

[matthew mueller]

Grant,

It is nice to find someone who is curious about Austrian economics. You raised some excellent questions. Let me make some comments.

1.) I would encourage you to read some Lachmann. He is a fine essayist, and his writing is always clear and powerful. He was sympathetic to all Austrians --- he spoke favorably of Mises, Kirzner and Hayek, and yet he was willing to criticize certain aspects of their work when he felt it deviated from subjectivism. He was also very sympathetic to some elements in Keynes' work (he actually read and understood it unlike Hazlitt and Rothbard!). Lachmann is a fascinating economist.

2.) About the externalities comment. I am referring here to the literature surrounding Coase's work on social cost. For Coase and his followers (Harold Demsetz and Carl J. Dahlman's EXCELLENT paper "The Problem of Externality"), there are no externalities because there are costs to using the market. For example, if the costs of addressing "public goods" are likely to be higher than the benefits, then it makes no sense to force the market to take these costs into account. And our world is full of transaction costs. This is a simple description of this work, and to really understand this point you have to consult the literature directly --- see Coase "The Problem of Social Cost"; Harold Demsetz "The Exchange and Enforcement of Property Rights"; and the Dahlman paper.

3.) If you are interested in money and credit, I would also suggest looking into the Post Keynesian approach to these problems, what is known as "endogenous money." What they do is reverse the causal arrow of the quantity theory of money equation to make the money supply a function of prices rather than the reverse, i.e. prices cause increases in the money supply. The money supply is endogenous rather than exogenous because banks must accomodate the demand for money. See Rousseas "Post Keynesian Monetary Economics" and Basil Moore "Horizontalists and Verticalists" and his several essays collected in the Journal of Post Keynesian Economics. I would like to see some work done by Austrians addressing these issues from their own (Austrian) position. (Austrians tend to be monetarists.)

4.) About capital reswitching. There aren't many Austrians who talk about capital theory today. Steven Horwitz has on occassion, but he hasn't really examined the implications of the Austrian theory of capital. Peter Lewin probably has done the most to extend and expound Lachmann's theory of capital, but he seems to be more interested in problems unrelated to Austrian economics. And Roger Garrison's capital theory is basically a restatement of Hayekian triangles. What all of this means is that the Austrians are simply unable to address the Post Keynesian-Cambridge capital contributions. Lachmann pointed the way but no one has yet followed his lead on this point. More work needs to be done in this area.

If you would like to talk about any of these ideas further, please feel free to email me at miller888sd@yahoo.com . I would be interested to see how your interests develop and mature. Do keep in touch!