This blog has been quiet

This blog has been quiet because I am writing a book on marriage, to be published by Connor Court, and have been composing essays, hopefully for publication.

Against Austrian business cycle theory

Former Austrian school economist Bryan Caplan recently won a bet against Austrian school economist Bob Murphy on the path of US inflation. Caplan won by betting with the key market indicator (TIPS), Murphy lost by betting against it.

At first glance, that the ex-Austrian won by following the market while the Austrian lost by not doing so might seem strange, but it instances why I am deeply unpersuaded by Austrian Business Cycle theory--that it is an analysis from a tradition that very strongly favours taking markets seriously (particularly their information revealing qualities) yet strikingly stops doing so to get a congenial theoretical outcome.

Austrian Business Cycle Theory (ABCT) is a theory of the unsustainable boom. It notes that capital is highly varied (or, economist say, is heterogeneous)--in particular, has a range of durations until completion. Interest rates coordinate current expenditure versus future income expectations.

If the central bank, in order to foster economic expansion, sets the key interest rate "too low"--that is, below the level that will create a stable level of successful capital projects--then entrepreneurs are led to over-invest in projects because capital is cheaper than its actual long-term prospects justify. So, there is misallocation of capital--the profile of created capital does not fit actual expenditure patterns. This is what Austrian theory calls malinvestment. The result is a surge in failed business projects, consequently of failed or distressed firms, leading to income and expenditure cuts, leading to that transactions crash we call "recession" or, if sufficiently severe, depression.

My objections to the theory are twofold: it doesn't fit the evidence and it is implausible even in theory.

Not fitting the evidence

The theory suggests that the long-term economic pattern should be one of a surge in economic output above trend (the unsustainable boom) and then a crash below it. This is not the pattern we see: on the contrary, what we see conforms much more to Milton Friedman's "plucking model" (pdf)--that is, there is a long term growth trend that recessions and depressions "pluck" the economy away from (pdf). A pattern which suggests the economy is pushed (temporarily) off its growth path by various shocks. Despite attempts to claim otherwise, I am unpersuaded that ABCT can be re-construed to fit the evidence.

Particularly as the theory also suggests that the crash should be correlated with the preceding boom--the further the capital overshoot, the worse the resulting crash. Again, this is not what we see (pdf). Recessions and depressions are not correlated with the preceding expansions, but are correlated with the subsequent expansions (pdf).  A result which led Friedman to propose his "plucking model". Again, this conforms far better with the economy being shocked off its growth path before returning to it.

Given that industries systematically vary by both the scale and duration of their capital creation, the theory also implies that the crash should hit in sequence and to varying degrees--the shortest capital duration industries hit first, the longest capital duration industries hit later; the lower scale capital industries hit least, the bigger scale capital industries hit most. These factors are, to a significant extent, contra-indicated--i.e. short duration capital projects also tend to be low scale capital industries while long duration capital projects tend to be high scale capital industries.

Even so, there should a capital-profile sequence to industry downturns. Again, this is not what we see: transaction crashes tend to hit all industries simultaneously. Such transaction crashes are most plausible assigned to the demand side (i.e. monetary factors) as, in a monetised economy, money is the thing which is one half of all transactions in all industries. Even when there are supply shocks, (1) monetary policy can counter-balance the effects and (2) such shocks are generally a specific shock to the economy, not rolling capital project failures.

One might counter by arguing that particular projects are engaged in a rolling fashion. But that reduces the industry sequencing issue at the cost of undermining the systematic distortion effect.

The theory also assumes that central banks are biased in one direction only--in an inflationary one. Yet the historical record shows that, while there is certainly a general inflationary trend for fiat money, there was no such trend by central banks under gold standards. And ABCT was originally devised in a gold standard world. Attempts to redefine "inflation" to mean "monetary/credit expansion" simply beg the question--an alleged cause being conflated into the presumed effect.

Moreover, the historical record also shows that, in the right circumstances, central banks can be biased in a contractionary direction. This was most dramatically true in 1928-32 but also true from 2008 onwards: on both occasions, the contractionary bias was because central banks prioritised policy credibility (commitment to the gold standard; commitment to low inflation) over economic activity. In doing so, contractionary central banks created the most severe economic downturns of the C20th[last 100 years]. A business cycle theory that is so dramatically wrong about the two worst economic downturns of the C20th[last 100 years]--central bank policy in the opposite direction as predicted and economies consequently being shocked off their growth path--is not much of a business cycle theory.

Implausible in theory

So, there are severe evidentiary problems with the theory as any sort of general business cycle explanation. Even saying "but it is just a theory of the unsustainable boom" suffers from the lack of instances it accurately describes.

There are also some serious theoretical problem with the theory. The first is, ironically, not taking heterogeneity of capital seriously enough. Heterogeneity of labour and of capital leads to heterogeneity of debt and debt/equity profiles. How can there be a key single, natural or otherwise, rate which can distort the entire structure of investment?  Including across its varying time frames, across which interest rates also vary.

What we are looking at is a schedule of interest rates varying by time and asset. It can be argued that the central bank policy rate (the interest rate used to signal policy) effectively anchors the entire schedule, as the central bank is the monopoly supplier of the monetary base. Its policy rate is really an indicator about the future path of monetary policy, and an indicator which is a function of it being said monopoly supplier and its policy credibility. But an indicator which has far more direct effects on nominal interest rates rather than real interest rates.

But to put so much emphasis on interest rates in investment decisions looks perilously like reasoning from a price change. The central bank has signalled, by cutting its policy interest rate, a more expansive path in monetary policy. But that is, for the economy, a general tendency: entrepreneurs still have to make assessments about particular assets and particular production decisions. As the localised nature of the housing market booms and busts in the US have demonstrated, housing markets experiencing the very same monetary policy can have very different dynamics.

The claim that entrepreneurs will be sufficiently homogeneous in their responses, across very heterogeneous asset and production markets, to create the bust looks suspiciously like only embracing complexity when it is convenient. (Noting that to claim more decisions to invest will be made is not the same as claiming that the structure of production will be distorted.)

More seriously, the claim runs into an information problem--as others have noted, Austrian theory apparently has access to information than none of the market participants do. The central bank knows enough to inflate the economy but none of the market participants have the knowledge to work out what the central bank is doing and the consequences thereof. There is a serious consistent expectations (i.e. rational expectations, but consistent expectations is a more accurate term) problem here.

In his (losing) bet with Bryan Caplan, Bob Murphy was being very "Austrian" in assuming his theory gave him information hidden from market participants--Austrian theory really, really believing in markets until it suddenly really, really doesn't. Bryan Caplan was being much more consistent (dare one say rationally consistent) in his expectations by going with the market indicator.

What is more plausible--that there is enormously-important-for-future-income information lying around being ignored by everyone except by clever Austrian school folk or that economies are shocked off their growth path: an economic shock being an unanticipated change?

Austrian school, meet the Australian economy

These theoretical and empirical problems come together in the record expansion of the Australian economy since 1991. That is, Australia has not had an economic recession (in the sense of two quarters of [negative] economic growth) since 1991. It still has a business cycle, just a very flat one.

What is more plausible--that the Reserve Bank of Australia (RBA) got its policy interest rate essentially correct for 23 years straight, so that Australian entrepreneurs got their capital projects (on balance) continually right? Or that the RBA sufficiently anchored inflation and income expectations that the Australian economy has not been shocked enough off its growth path since RBA introduced its policy of aiming for a 2-3%pa inflation rate on average over the business cycle ?

Surely, the second option is much more plausible.

So, I do not agree with the Austrian School business cycle theory. In particular, I am very unsurprised that an Austrian economist lost by betting against the key market indicator. The Austrian Business Cycle theory presumes special knowledge against market agents and the indicators they generate: a presumption which is not a strength. Still less a reason to accept the theory.


[Cross-posted at Skepticlawyer.]

Hard money is not the same as sound money

A post by Jonathan Finegold on sound money pointed me towards how to express an important distinction--that hard money is not the same as sound money. JF defines sound money thusly:

a monetary system that best promotes coordination between market agents.

Unsurprisingly, a somewhat "Austrian" definition, but clear enough. I would go with the money that maximises its transaction utility, but it would come to much the same thing. Which is to say, money being sound is not merely about the exchange value of money (either for other monies or for goods and services), nor even its exchange value across time (i.e. its role as an asset), but also about the exchanges (transactions) it is used in. If money maintains or increases its exchange value against goods and services (measured by, say, the GDP deflator) but at the cost of depressing the level (measured by goods and services) of exchanges it is used in, then that is not sound money.

It is, however, hard money. 

Which is the difference: hard money is money that maintains or increases its exchange value for goods and services (or other monies or both). The more it increases its said exchange value, the "harder" it is. But that does not tell us that how sound it is: indeed, often hardness and soundness are contra-indicated (more of one is less of the other). To increase money's value as an asset is to reduce its moneyness and that way disaster (or, at least, much economic unpleasantness) lies, remembering that being an asset is the least distinctive thing about money.

Deflation distinction

The distinction between good, bad and ugly deflation is useful (pdf) here. Good deflation comes from falling prices due to increasing productivity. The IT industry is a classic example of good deflation--Moore's law and all that. There is a sense in which the entire increase in living standards from whenever is all good deflation--if, for example, we use labour-time at average wages as our measure.

Bad and ugly deflation--what we might call monetary deflation--is all about money increasing in value relative to output, thereby depressing aggregate demand (i.e. total spending on goods and services), pushing downwards on income, raising the value of debt. Bad and ugly deflation is from hard money, from money increasing in exchange value. It is not sound money, as the actual use of money in productive transaction is trending downwards as money's exchange value is trending up. Money-as-asset is overwhelming money-as-facilitator-of-transactions--the real point of money; what makes money, money.

Central banks should be sound, not hard
We do not want central banks to obsess over providing hard money, we want them to provide sound money. To focus on money as tool, not money as asset; to focus on its utility, its role in the economy as a whole, not on its (exchange) value. Narrow inflation targeting central banks--such as the Bank of Japan (BoJ) during the "lost decades", the European Central Bank (ECB) since the Eurozone crisis--produce hard money. They do not produce sound money. The Reserve Bank of Australia (RBA) does that.

The most disastrous example of producing hard money which was desperately unsound was the policies of the Bank of France (BoF) in creating the Great Depression, the classic example of ugly deflation at its ugliest. Money was extremely hard (and getting harder and harder) but also catastrophically unsound. Money was "better and better" as an asset, worse and worse as a facilitator of transactions.

One problem is that hard money is actually relatively easy to produce and has a whole lot of ready-made chest-thumping rhetoric to go with it. It does not help that Austrian school theory has such a presumption towards central banks being inflationary, that the problem of hard money is simply not natural to their analytical framework. (Not a sin of all Austrian economists--several above links are to works by economists associated with the Austrian school--but one very common in the wider Austrian community.)

Disorder dangers
Another problem is the conservative penchant for producing fetishes of order--such as "preserving" the "value" (rather than the utility) of money. Hence so many conservatives riding the gold standard down to destruction in the Great Depression and so many obsessing over utterly imaginary inflationary dangers today. They focus on money as asset, losing sight of money as tool. On the thing itself and not its wider role, thereby actually failing to defend the wider system. They defend the fetish (the gold standard, narrow inflation targeting) as a bulwark of order, regardless of how much actual disorder it is creating.

Thereby, of course, undermining and discrediting the very social order they are so keen to defend.

Including the international order. Not only does the social disorder created by hard money make extremist regimes more likely, the economic contraction and stagnation hard money creates undermines the confidence and capacities of Western states. Folk have pointed to how much like a late 1930s Hitler Russian President Vladimir Putin is, except on behalf of Russians outside Rodina rather than Germans outside the Reich. That both were confronting Western Powers weakened in both strength and confidence by central bankers disastrously pursuing hard, rather than sound, money policies is another similarity less remarked upon.

Money qua money is a tool for transactions. Sacrificing its use (in transactions) for its (exchange) value is to undermine its real utility to an economy--which is to facilitate transactions, to have maximum transaction utility; to have a monetary system that best promotes coordination between market agents. 

Hard money is really, really not the same as sound money.  It would be a massive step forward in public policy if more people understood that.


[Cross-posted at Skepticlawyer.]

More on the reactionary effect of Marxism

Over at Skepticlawyer, I was challenged on my claim that

Leninism (or derivatives thereof) proved to be the only effective way to politically operationalise Marxism

The claim was a little over-stated; Leninism (or derivatives thereof) proved to be the only distinctive effective way to operationalise Marxism. Marxism did motivate the formation of trade unions and Social Democratic political parties (or, at least, providing the animating ideology). 

But, of course, there was nothing particularly distinctive about that in that proved to be entirely possible to have trade union movements and working class-based political parties without any significant Marxist element at all.  And, to the extent that there was a distinctively Marxian element, the effect also proved to be reactionary.

For the more identified with Marxist ideology the Socialist/Social Democratic Party was, the larger the Leninist offshoot after 1917. The larger the Leninist offshoot, the larger the countervailing Fascist/Nazi/Authoritarian movement was.

Moreover, the larger and more threatening the Leninist offshoot was, and the more identified with Marxist ideology the Socialist/Social Democratic Party was, the more ignored rural voters, particularly peasant smallholders, were and the more the Fascist/Nazi/Authoritarian Right movement was able to mobilise them as a voter and support base.

Moreover, Leninism provided Fascism and Nazism with a model of how to operationalise politics. This is most obvious with Mussolini--as he both wrote about it and came directly out of the same radical-Left socialist milieu as Lenin et al--but not much less so with Hitler. If Lenin was Marx + Robespierre -- as Lenin Jacobinised Marxism -- then Mussolini was Mazzini (or perhaps Garibaldi) + Robespierre while Hitler was Gobineau + Robespierre (with added anti-Semitism). And Lenin provided the model of how to operationalise total politics for whatever one's project was (national greatness in Mussolini's case, Aryan race-purity-and-dominance in Hitler's case).

Those Socialist/Social Democratic Parties that remained on the free side of the Iron Curtain effectively dropped the deadweight of Marxism, going on to prove how unnecessary Marxism was to have an effective Labour/Social Democratic/Socialist party and trade union movement. Even beneficial, since an official Marxist ideology got in the way of coalition-building, scared (some) voters while jettisoning it permitted a more effective electoral and policy pragmatism without the ideological blinkers.

The later Eurocommunist movement was attempt to distance the Parties involved from the the deadweight of revolutionary Marxism (i.e. Leninism), becoming more like the Parties that had Never Gone There or had effectively dropped Marxism. With precious little actual Marxism after that was done -- and the more there was, the less successful the Party tended to be in the longer term.

A for the involvement of Marxism in various progressive social movements, the history of the Emancipation Sequence in the Anglosphere (abolition of the slave trade, then slavery; Catholic Emancipation, Jewish Emancipation, Female Emancipation, the civil rights movement, indigenous emancipation, now queer emancipation) also demonstrates how unnecessary Marxism is and was for the sequence.

Certainly, Marxists got involved in the later movements, but that was a very mixed blessing. They tended to get in the way of the broader coalition building that allows such movements to succeed by making the movement seem more broadly dangerous, provided broader ideological baggage that diverted energies and focus that generally got in the way.

On balance, Marxism has been far more a destructive deadweight for progressive movements than a benefit. Not least for its tendency to give its adherent the belief that they know what people should want/need rather than what they actually want/need. 

It may not be a coincidence that the only surviving full Marxist regime is the most atavistic of the lot -- the quasi-religious dynastic theocracy of North Korea. By so thoroughly embracing the atavistic core of Marxism -- this notion of prophetic understanding of the direction of history far greater than other mortals not blessed with understanding of the true doctrines which will provide a salvation that will eliminate all alienation -- the Kim Family Regime has continued when elsewhere Marxism as an significant political force has collapsed, yet another casualty of the historical tsunami of modernity.

I will return

I have been blogging regularly at Skepticlawyer.  My posts there will turn up here, eventually.

The protection of the public eye

Blogging in Cuba is not the safest of occupations. Here is a request, received by email, by and on behalf of such bloggers:

Many people want to do something to help the bloggers directly. The most important thing is to read them, talk about them, comment on their blogs, share their blogs with others, keep them IN THE PUBLIC EYE, which is a shield that helps to protect them.

So, here are some blogs to follow:

Generation Y

Sin Evasion/Without Evasion

Laritsa's Laws

Octavo Cerco

Dimas's Blog

I broadly understand the current economic circumstances, I read Scott Sumner

My favourite economic blogger is monetary economist Scott Sumner, who blogs at The MoneyIllusion.

Monetary economics is a difficult area, for money is both ubiquitous – it is a feature of all transactions that use money – and has roles across time. By the frequency and clarity of his posts, and his willingness to engage with his commenters, Scott Sumner provides, in effect, an ongoing public seminar in monetary policy.

Particularly as one can ask a question and have a very informative answer from some of the excellent other commenters on the blog.

But it is the quality of his posts that is the real value. Sumner has, for some years, been writing a book on the Great Depression of the 1930s. His approach has to been to immerse himself in the data, including the issues of the New York Times of the period. (He has posted an introduction to his analysis of the 1930s here and excerpts from some chapters of his book here, here, here, here; here, here, here, here; here, here, here, here and here with a clarification post here and a useful summary of his views here. He has a lovely takedown of Woodrow Wilson here.) This gives his application of the lessons of the 1930s an empirical depth that is invaluable.

As long as it is applied to an appropriate analytical structure: it is not merely that Sumner is steeped in the empirical data, it is that he applies economic analysis in an open-minded way to the data that gives his posts their value.

He recently published a piece in National Review arguing for his preferred approach to monetary policy – targeting the level of nominal GDP (NGDP: GDP in money terms). NGDP is the money value of the total number of productive (in the sense of incorporated-in-GDP) transactions in a given time period.

On the way through, he provides a very clear analysis of recent economic travails. We suffer from a re-run of Irving Fisher’s analysis (pdf) of the 1930s Great Depression – a combination of the “debt disease” with the “dollar disease”.

Yes, there had been a vast expansion in use of credit/debt and the role of the financial sector in the global (and particularly American) economy. But the crucial problem was a dramatic drop in nominal GDP as the result of the US Federal Reserve’s shift to a “tight money” policy, for:

Since most debts are nominal (i.e. not indexed to inflation), nominal income is the best measure of a person’s ability to repay their debts. In 2009, the U.S. saw the biggest fall in nominal GDP (NGDP) since 1938. It is thus no surprise that we had a debt crisis: Borrowers almost always have trouble repaying debts when nominal income comes in much lower than was expected when the debts were contracted.

There was a general expectation about growth in total transactions/economic activity – and so money incomes – which were collectively frustrated. The result was both a dramatic economic contraction AND a dramatic increase in “bad” debts.
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Pausing here, this is why I am deeply sceptical about the Austrian economics concept of malinvestment, particular as an explanation of business cycles: a investment which is fine at one level of economic activity is not at a lower one. A business that may well be a perfectly reasonable investment in inner city New York may be a deeply silly one in Port-au-Prince. So, that a drop in the general level of economic activity results in increased bankruptcies is not a sign of “malinvestment”. On the contrary, a business that fails in boom times is much more a sign of malinvestment.

What Sumner wants of a central bank is:

I am asking the Fed to provide a stable policy environment for the negotiation of wage and debt contracts.

Something the Federal Reserve in the US failed to do, but the Reserve Bank of Australia has continued to successfully do.

Such widespread frustration of money income expectations due to a drop in nominal income has all sorts of knock-on effects:

Government workers in 2009 were being paid salaries negotiated under the expectation that NGDP would rise at about 5 percent, as it had (on average) for several decades. When actual NGDP fell 8 percent below trend, those wage contracts boosted the share of national income going to the employees still working, at a cost of much higher unemployment for the rest of us.

If government employees are systematically shielded from economic circumstances, this may both encourage talent into the government sector and discourage public policy from being sensitive to such things as high or persistent unemployment. Europe is currently providing some object lessons in why that might be a long-term problem.

On the way through, Sumner provides in his National Review piece a very lucid discussion of precisely why the gold standard is not a solution, again based on his understanding of the historical data.

But this informative lucidity is not some unusual aspect of Sumner’s blogging. This post, for example, provides an excellent “in” to the current, parlous, state of macroeconomics. From reading Sumner, and particularly his comparisons of current circumstances with those of the 1930s, one can see how mad concerns about some looming outbreak of inflation are (and how these are yet another re-run of the 1930s, of which he can identify a depressingly large number of parallels).

Do read his entire article, and then start reading his blog.

In defence of (econ) blogging

This is an extension of comments I made here, here and here.


A Richmond Fed economist, Kartik Athreya, thinks bloggers in general should shut up about economics because economics is very hard, so very hard to do properly. The essay has provoked a lot of responses.

A thorough response here, an even more forensic response here, a brutal response here, a nuanced response here, a considered response here, a response on the virtue of extra information here, a re-awakening intellectual joy response here, a benefits-for-information (and limits to macroeconomics) response here, a pointed limits to macro-economics response here, a philosophical response here and a somewhat supportive response here.

That people responded, and often very thoughtfully, is hardly a sign that what they do as bloggers on matters economic has some insecure status, as suggested in the supportive response. Surely it simply shows they take credentialed offerings from the Fed system seriously?

Secondly, what is the significance of something being blogged? As I noted at Scott Sumner and Will Wilkinson's posts, a blog is just online self-published opinion pieces. Unless one has some great belief in the gate-keeping qualities of opinion page and magazine editors, it is no different than what economists have been doing in opinion pieces in newspapers, magazines and journals for lay audiences since, well, economics started. Should Malthus, Mill, Marshall, Keynes, Friedman, Hayek, Marx etc all have shut up and stayed in the professional journals? Athreya’s essay comes across as moral panic about a new technology mixed in with guild ("you have to be the right sort of person in the right sort of place") restrictionism.

For an example of the usefulness of econ blogging consider this short history lesson in macro-economics. Blogging makes this information available to far more people, far more easily.

I find online materials an enormously useful ocean of resources. Yes, you have to be discriminating, but that is true of any set of materials and information sources. That it so lacks gate-keeping restrictions can be a problem, but it is far more of an advantage. Blogging is only part of that ocean of resources, but to pick on blogging in general is a nonsense, an analytical failing of major proportions.

In the end, Athreya is complaining about an arena with low transactions costs and few limits to entry: a very odd thing for an economist to be complaining about. Usually, when people complain about low transaction costs and ease of entry, it is because they want to preserve some sort of privilege and/or sense of status. Which does seem to be what Athreya is actually about, at bottom.

(But I did enjoy the crack about Delong and Krugman's "we are obviously right" fiscal stimulus prescriptions:

... some who might know better. They are the patron saints of the “Macroeconomic Policy is Easy: Only Idiots Don’t Think So” movement: Paul Krugman and Brad Delong. Either of these men will assure their readers that it’s all really very simple (and may even be found in Keynes’ writings).

Perhaps Athreya could take up blogging ...)

UPDATE Scott Sumner makes one of those comments:

If you read Brad DeLong, you probably notice that he is a bit in awe of Krugman’s ability to be right about everything. Actually, Krugman isn’t right about everything, but he tends to be wrong about exactly the same things that DeLong is wrong about, and so DeLong wouldn’t notice those things.

Who said economics ain't fun?

Guest post on Norton and Foucault

I have a guest post at skepticlawyer elaborating how Rictor Norton gets stuck into Foucault and some related matters.

Apologies for less posting

Apologies for the drop-off in posting. I have been sick and busy (self-employment, no sick leave) which means a lack of energy to post in the evening when I get home.

Things should start improving as I am feeling better (good) and work is falling off (not so good).

Still not online at home

Hence the lack of posting. It should all be back up and running on Friday though!