New Working Papers on the Current Recession

Both Pete B. and I were asked to contribute Austrian perspectives to a volume entitled The Meltdown of the World Economy: Alternative Perspectives on the Global Financial Crisis, edited by Steven Kates and published by Edward Elgar Publishing.  Both of our contributions are now up on the Mercatus Center Financial Markets Working Group site as working papers (PDFs).

Horwitz:  "The Microeconomic Foundations of Macroeconomic Disorder: An Austrian Perspective on the Great Recession of 2008"

Boettke and Luther:  "The Ordinary Economics of an Extraordinary Crisis"

Comments

[Sinclair Davidson]

Some gratuitous advertising, my RMIT colleague Steve Kates blogs at catallaxy (link at the 'Blogs we like'.

[Greg Ransom]

Just outstanding, Steve.

I'll take a look at Pete's paper later.

[K Sralla]

Steve, this is an excellent paper from a public intellectual standpoint. It deserves to be read by any layman interested in a good overview of the basics of Austrian cycle theory and its application to the current recession. I only wish it could be disseminated in some form to a wider readership (maybe a condensed version submitted to a popular business journal?) The layman desperately needs to understand the danger of public policy combined with central banking to set off these specific types of cycles (housing bubble), and yet the "dynamic duo's" impotence in being able to cure their own mess. Apparently many economists need to think more deeply about this too! Great work!

[Steve Horwitz]

Thanks K. In fact, two of your host bloggers may well be starting a project to bring this to a broader audience in the near future. Stay tuned.

[Greego]

Both papers are excellent and should be easy for non-economists to understand (testing that hypothesis on my brother and girlfriend now!) Thanks for sharing some great work.

[Lee Kelly]

Both papers are good, both in content and writing.

[Daniil]

Steve, as a libertarian I've long been sympathetic with the Austrian view of crises. Yet I always had a problem with the way the Austrians make a logical step from the artificial credit expansion to the lowering of the real interest rate.

In your article you propose a mechanism for that. You say that when the enterpreneurs observe that they are getting access to more credit they mistake it for a change in the intertemporal preferences of the consumers for more savings.

Is there any evidence that the enterpreneurs really think that way?

[Chris Braun]

That's the one thing with which I have a problem too: Given the current monetary system, why would anyone be moved to assume that a drop in interest rates means a change in consumer time preferences?

Steve Horwitz writes:

"When money is in excess or deficient supply, interest rates lose their connection to people’s underlying time preferences and individual prices become less accurate reflectors of the underlying variables of tastes, technology, and resources."

But with the present monetary system, isn't any apparent connection of interest rates with time preferences always going to be, at best, no more than the result of good guesswork on the part of central bankers, that is to say, hardly better than accidental? There surely is no necessary connection, and entrepreneurs and managers would surely have to be idiots to think, given today's non-commodity-based, non-laissez-faire monetary system, that there is any necessary connection. I don't think they'd even have reason to think this. So I too wonder: Is there any evidence that they really think that way?

It seems to me that the theory assumes that entrepreneurs and managers react to interest rate changes that are realized as a result of decisions made by central bankers as if these changes are the kind of spontaneous changes one could expect from a free-banking system - a system of which no entrepreneurs or managers working today have ever had any experience, and of which very few have even vague knowledge.

[Steve Horwitz]

This is a great question Chris and one that has been raised as a criticism by many others. I think the best response to it is a paper by Carilli and Dempster: http://www.gmu.edu/rae/archives/VOL14_4_2001/4_carilli&dempster.pdf

Here's the abstract:

The standard account of Austrian Business Cycle theory posits that central bank manipulations of interest rates fool bankers and investors into believing that there has been an increase in the real supply of loanable funds available for capital investment. However, reliance on “foolishness” ignores the entrepreneurial emphasis within the Austrian tradition and fails to produce the strongest possible case for Austrian Business Cycle theory. We use the prisoner's dilemma framework to model the profit maximizing behavior of bankers and the investors under uncertainty when the market rate of interest is below the underlying rate of time preference."

They argue that the PD framework can explain why entrepreneurs still are willing to undertake investments at the low rate even if they think it is not reflective of real preferences. It's always better to borrow than not borrow given the actions of others.

As they say, read the whole thing.

[Chris Braun]

Steve: Many thanks for the reassurance that Daniil and I are not barking up the wrong tree.

The relevant section of the paper you suggested makes a lot of sense to me.

[Nikolaj]

Steve, excellent article, although there is one curious and frankly, astonishing thing. You consider, except understandably Mises and Hayek, Horwitz and Garrison as two leading theoreticians of ABCT. You eliminated Rothbard from the club of most important ABCT theoreticians completely, and promoted yourself instead. I know you don't like Rothbard, but don't you thing that was little over the top?

[Steve Horwitz]

Not really Nikolaj. I actually don't think Murray contributed much that was new to the *theory* of the business cycle. The first chapter of America's Great Depression is a very good summary of the theory, but it suffers from its link to 100% reserves. The rest of the book is extremely important as an application of Austrian ideas. I recently used that book in class and I have another paper on the Great Depression that cites MNR frequently.

So this is not Rothbard animus. It's not that I "don't like" Rothbard. I wouldn't be a libertarian if it weren't for him. As I've said before, I think MES is a great book, esp. the first 66 pages. But I cite Murray where I think he's made contributions that advance ideas. I simply don't think his work on the cycle moved things forward all that much, and it's muddied by his policy prescription.

I think Murray was right about a lot of things, but monetary theory wasn't one of them. Thus, I tend not to cite him on the cycle.

[Guillermo Barba]

Excellent articles. I think they complement each other. Congratulations.
I have two observations. One, it a matter of semanthics. When you mention that the assumption of self-interest is precluded. Well, if human beings, in order to "remove the felt uneasiness", try to use means to attain ends, one can 'interpret' that as following self-interest.
The second one, is when you mention that: "The boom can not last because the underlaying preferences of consumers have in fact not changed..." If interest rate is artificially reduced by monetary policy, it is likely that consumers will decide to be even less willing to wait for longer output, which will lead to increase present consumption, and making the gap between ex-ante saving and ex-ante investment even bigger.