Coordination Problem

The Chicago Plan Revisited

|Peter Boettke|

That is the title of a new working paper from the IMF.  I would be very interested in hearing the opinions of Steve Horwitz, Larry White, George Selgin, Gearld O'Driscoll and Richard Ebeling on this discussion of the reconsideration of the Chicago Plan as an answer to financial instability.

Just the other day I was speaking with David Levy about Leland Yeager's In Search of a Monetary Constitution, and in particular Murray Rothbard's contribution to that volume.  One must realize that Rothbard's positon is not out of step in the least withn that context.  Rothbard is, as we all know, an advocate of a full-reserve system.  But that is not as unusual as one might first think. Irving Fisher, Henry Simons, and Milton Friedman all wrote defenses of full-reserve banking.

An argument for limited purpose banking has been put forth in Lawrence Kotlikoff's Jimmy Steward is Dead as well, though see Richard Wagner's review.

Lionel Robbins on the Importance of Scholarship Within Economics and Economic Policy

|Peter Boettke|

I will be teaching Modern History of Economic Thought again starting tomorrow (Econ 821 in the GMU catalogue of classes for PhD students).  This term I am going to try to emphasize the evolution of economic thought through the 20th century not in terms of abstract theoretical and methodological disputes, but instead as the by-product of the play between ideas and public policy.  In doing so, I hope to contextualize the intellectual history of modern economics.  To get an idea of what I am talking about consider this statement from the beginning of Lionel Robbins's The Theory of Economic Policy in English Classical Political Economy (1952):

"When I began to study economics, thirty years ago, the senior generation of economists in this country -- Marshall, Edgeworth, Foxwell and Cannan -- were all men who, in their different ways, were truly learned in what may be called the scholarship of the subject; and some acquaintance with the history of economic thought was usually deemed to be a desirable part of the equipment of the economist. But, in the years that have passed since then, this kind of knowledge has come to be regarded as a very unimportant embellishment, as inessential to the economist as a knowledge of the history of chemistry is said to be inessential to the chemist. This development has always seemed to be to be unfortunate. I do not think that, even in the purely analytical field, our knowledge is so far advanced to justify us in writing off as superseded the propositions of all but our immediate contemporaries; and, in the applied field, I do not think we can hope to understand the problems and policies of our own day if we do not know the problems and policies out of which they grew. I suspect that damage has been done, not merely to historical and speculative culture, but also to our practical insight, by this indifference to our intellectual past -- this provincialism in time -- which has become so characteristic of our particular branch of social studies."

But what is Robbins argument for a more scholarly as opposed to scientistic understanding of economics? What is the "Kuhnian loss" that he identifies when he states "I suspect that damage has been done"?  It cannot just be his preference for old books.  And, it cannot just rely on catchphrases in the public discourse such as "Those who ignore the pass are condemned to repeat it."  What actually is the argument underlying the plea for scholarship in the training of economists that will meet the argumentative burden set by the intellectual status quo in economics?

Ezra Klein Mistakes the Arsonist for a Firefighter

Steven Horwitz

In Friday’s Washington Post, Ezra Klein raises a number of criticisms of the gold standard using as his hook the call for a new Gold Commission that appears in a draft of the new Republican Party platform.  Putting aside the question of party politics and what a new Commission might do, Klein’s arguments against the gold standard are not as strong as he thinks.  I want to respond to three of them here, and in reverse order of importance.

He argues, as many do, that tying the dollar to gold means that the value of the dollar will vary with the “global price of gold as opposed to the needs of our economy.”  There are several problems here.  First, are the fluctuations in the price of gold any greater than the current factors that affect the value of the dollar, including changes in the judgment of Federal Reserve officials and the politics of money creation?  In fact, one could argue in response that the major cause of fluctuations in the price of gold is the very fact that the Federal Reserve has discretion over the money supply and thereby affects inflationary expectations, which in turn destabilize the price gold.  The variance in the price of gold is not exogenous to the monetary regime.  In other words, a gold standard might dramatically reduce the variance in the price of gold, avoiding the problem Klein raises. 

And does Klein really believe that the Fed currently adjusts the value of the dollar according to “the needs of our economy?”  Is the Fed totally immune from political concerns?  Does the geo-political situation matter not at all for its decisions?  We have some evidence of political business cycles, which suggests that the Fed is hardly pure in its intentions.  Klein commits a version of the Nirvana Fallacy by setting up his comparison as that of an imperfect gold standard versus an idealized Fed.

Like many pundits, Klein also never precisely defines what he means by a “gold standard,” which the GOP is guilty of as well.  Does he mean Federal Reserve Notes backed by gold, or does he mean a system of gold coins?  If the former, with what reserve ratio?  Better yet, he never asks the most important question:  some of us who would like to see gold have a role in the monetary system want it to be in the context of a purely competitive banking system that does not require a central bank.  Some of the other issues Klein raises in his column would be non-issues if by a “gold standard” one means closing down the monopoly of Fed and allowing banks to produce currency and deposits competitively. 

Finally, and most important, Klein argues that a gold standard would prevent the Fed from acting as a lender of last resort and preventing financial collapses as it supposedly did in 2008.  Putting aside whether the Fed’s actions were, in fact, necessary or how much they helped, Klein misses the bigger picture.  If we had a commodity-based free banking system, we would not have had the boom and bust of the 2000s in the first place.  The powers that enable the Fed to create liquidity ex nihilo in a crisis are the very same powers that enabled it to drive the real Federal Funds rate below zero for two years and fuel the housing bubble, which gave us the financial crisis and recession. 

Remember: the Fed is like the arsonist disguised as a firefighter who claims only he can put out the fires he started.  Yeah, maybe the firefighter can’t rescue people from the building if he doesn’t have an axe to break down the door, but giving him a way to break in makes it far more likely that he’ll set fires in the first place. 

Claiming that a gold standard ties the Fed’s hands is exactly the reason to favor it, not oppose it. The Fed was primarily, though not solely, responsible for getting us in this mess in the first place precisely because its hands were free to flood the market with artificially cheap credit. 

The discretion of Big Players like the Fed is the problem, and the solution is not somehow hoping that next time they will use that discretion only for good and not evil.  Tying Federal Reserve Notes to gold would take away some of that discretion, and eliminating the central bank completely in favor of a competitive monetary system with commodity backing of any sort would take it all away. 

When the arsonist can’t set fires, we don’t need to worry about whether or not he has the tools to put them out.  That is the fundamental argument for constraining both central banks and competitive ones by making the money they create redeemable in gold.

(Complex?) Thoughts on Heterogeneity and Complexity; Quality and Quantity

|Peter Lewin|

Considering the concept of heterogeneity throws light on the relationship between quantity and quality.

All observation and explanation proceeds on the basis of classification (categorization). Phenomena are grouped into categories according to our perception of their essential similarity (homogeneity). The elements of any category (class) might be different in some respects, but in all respects that ‘matter’ to us they are identical. Items within a particular category can be counted, quantified. The ability to quantify is crucially dependent on being able to count items in this manner. The number and type of categories (variables) is known and fixed. Thus, the arrival of a new category cannot be accommodated within a scheme of simple quantitative variation and must be considered to be a change in quality. Qualitative differences are categorical differences.

All quantitative modeling proceeds on the basis of the assumption that the individual elements of any given quantifiable variable are identical (homogeneous) and are different in some important respect from those of another variable. Variables are essentially distinguishable categories. In addition the elements of a quantifiable category do not interact with each other – else they could not be simply counted. Each element is an independent, identical instance of the class. (Most obvious is the case of ‘identical randomly distributed variables’). This does not preclude the elements themselves being complex – being the result of lower-level interactions, like identical molecules or biological cells, which are incredibly complex phenomena.

We may think of this in terms of structure. Structure implies connections/interactions. A structure is composed of heterogeneous items that are more than simply a list of those items. There is a sense of how the heterogeneous items work together to ‘produce’ something. (We see here how a capital-structure is both a metaphor for and a particular case of the phenomenon of complex structures in the world.) A structure is an ‘order’ in Hayek’s sense, in which it is possible to know something about the whole by observing the types and the ways in which they are related, without having to observe a totality of the elements. Structures are relational. Elements are defined not only by their individual characteristics but also by the manner in which they relate to other elements. These interactions are, in effect, additional variables.

Thus, though the elements of a quantifiable category may be unstructured, these elements may be composed of structured sub-elements. This is the basis of the phenomenon of modularity. Self-contained (possibly complex) modules may be quantified. This dramatically simplifies the organization of complex phenomena, as has been noted in a fast growing literature on the subject. Modularity is a ubiquitous phenomenon in both nature and in social organizations. It is an indispensable principle of hierarchically structured complex systems. The benefits of modularity in social settings include the facilitation of adjustment to change, and of product design, and the reaping of large economies in the use and management of knowledge (see for example work by Baldwin and Clark 2000, Langlois 2002, 2012) and it is clearly an aspect, perhaps the key aspect, of Lachmannian capital-structures. Capital-goods themselves are modules, which are creatively grouped into capital-combinations which constitute the modules of the (non-quantifiable) capital-structure.

Returning to the theme of the relationship between quantity and quality, quantitative modeling works when both the independent and dependent variables are meaningful, identifiable quantifiable categories that can be causally related. The model ‘works’ then in the sense of providing quantitative predictions. The inputs and outputs can be described in quantitative terms. But, when the outcome of the process described by the model is a new (novel) category of things, no such quantitative prediction is possible. Ambiguity in the type and number of categories in any system destroys the ability to meaningfully describe that system exclusively in terms of quantities. We have a sense then of the effects of heterogeneity. Variation applies to quantitative range. Heterogeneity (variety) applies to qualitative (categorical) range. Diversity incorporates both, but they are significantly different. Heterogeneity may not be necessary for complexity, but heterogeneity does militate in its favor. For example, compound interaction between quantitative variables (categories) can be an important characteristic of complex systems, but complex systems are likely to result from substantial heterogeneity, especially where heterogeneity is open-ended, in the sense that the set of all possible categories of things is unknown and unknowable.  

Heterogeneity rules out aggregation, which, in turn, rules out quantitative prediction and control, but certainly does not rule out the type of ‘pattern prediction’ of which Hayek spoke. In fact, erroneously treating heterogeneous capital as though it were a quantifiable magnitude has led to misunderstandings and policy-errors, such as the those associated with the connection between investment and interest rates - errors that could have been avoided with a better understanding of capital heterogeneity and its effects. The capital-structure is complex, but it is intelligible. We can understand and describe in qualitative (abstract) terms how it works and render judgment on economic policies that affect it. And, as a result of Hayek’s insights into complex phenomena, we have an enhanced appreciation of what is involved.

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Baldwin, C. Y and K. B. Clark (2000), Design Rules (Cambridge, Mass.: MIT Press).

Langlois, Richard N. (2002), ‘Modularity in Technology and Organization,’ in Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization, N. J. Foss and P. G. Klein, 24-47. Aldershot: Edward Elgar,.

Langlois, Richard N. (2012), ‘The Austrian Theory of the Firm: Retrospect and Prospect,’ Review of Austrian Economics, forthcoming.

 

Some Austrian Thoughts on the Problems with Stimulus Spending

Steven Horwitz

I share them over at the LSE blog this morning.  A snippet:

"Politicians who are structurally unable to know how best to allocate stimulus resources will inevitably distribute them to those persons and groups who will give them the most electoral support. The Austrian caution about the limits of politicians’ knowledge suggests that no matter what is drawn up on the blackboard, the politicisation of stimulus spending is not an accident and cannot be avoided. Stimulus spending that goes to groups that will provide the most votes will ensure that the right combinations of capital and labour will not be formed."

Understanding the Jobless Recovery

|Peter Boettke|

This is a classic overselling of the paper, but Will Luther and I have written a paper surveying the contribution of the Austrian school of economics to the field of labor economics.  We focus our efforts not just on textual examination, but also analytically on the Alchian-type friction-laden discussion of resource allocation, and the process of exchange and production.

Comments/criticisms most welcomed.

Julian Simon Wins Again, But Will Anyone Learn?

Steven Horwitz

You may have seen this AP story on the "surprising" drop in CO2 emissions, bringing them back to 1992 levels.  One explanation for this drop is that a number of US power plants have shifted from caol to natural gas.  The latter drastically reduces CO2 output/emission.  So what explains this switch?

Well to economists it's no surprise:  relative prices.

Natural gas has become significantly cheaper, leading more plants to switch over.  One reason gas is cheaper, of course, is fracking technology.  So our environmentalist friends have a bit of a quandry here:  opposing fracking means opposing cheaper natural gas, which means opposing getting rid of those dirty, CO2 producting coal-fired power plants.  Once again, profit signals lead entrepreneurs to find substitutes for expensive, dirty processes, in turn leading them to develop new technologies that create usable and valuable resources where none exisxted before.  This drives down prices of that substitute, which leads to it replacing the old dirty technology. 

Julian Simon, take a bow. 

If you read the AP story, you will find the usual environmentalist hemming and hawing about how "this isn't really a solution" and the "irony" of natural gas reducing CO2 emissions.  It's not ironic folks.  You think it's ironic because you refuse to listen to what economists and people like Julian have been saying for decades:  markets solve these problems better than top-down mandates. 

Note also the surprise at the fact that power plants converted so quickly from coal to gas.  This is not surprising to anyone witih a basic knowledge of economics.  Profit signals are powerful and people respond to relative price changes.  That's Econ 101, week 2.  The same folks who are surprised by this were also surprised by the quick conversion after WWII.  Surprise in this case is just a fancy word for "ignorance."

The evidence for the arguments of Julian Simon and others has perhaps never been more clear than in this story, yet the real dogmatists are not those of us who are skeptical not of climate change science but of the accompanying social science and policy, rather the dogmatists are those who keep denying the power of market processes even when the evidence is right in front of them.

Is it too much to ask for that examples like this might lead to some rethinking of their dogma?  Probably.

Thinking about governance from the perspective of bad movies.

|Peter Lewin|

The other part of Pete Boettke’s focus on behavioral economics and the challenge to rationality is: what kind of people are in charge? Does it matter? I mean there is the familiar knowledge problem (and also the “rationality” of the leaders, the designers of the framework of choice); and there is the problem of integrity or morality.

In the world of Hollywood, there are only two kinds of people, good guys and bad guys. The typical action story is about a government-run diabolical cover-up of a diabolical national-security project hatched and run by diabolical government agents. Witness the latest incarnation of same: The Bourne Legacy. The members of this genre abound. This is the stuff of pop entertainment. It works because we are outraged by the behavior of the bad guys and buoyed by the actions of the underdog heroes (acting for all of us) who oppose them and ultimately prevail. Notice that the plot depends on the unraveling of an oppressive system/project hatched and run by the bad guys because of the conscience-driven behavior of some good-guy(s). In other words, someone defects and all hell breaks loose. Frequently an attempt at a cover up leads to further embroilments and so it goes – through (to date) four parts of the Bourne story and hundreds of millions of dollars later. Clearly the system, depending as it does on the good-faith cooperation of all of its participants, is very fragile.  There are some incentives, but they are not fail-safe.

Now, it’s true, of course, that some of these bad guys think they are actually the good guys. They are working for some greater good - keeping us safe from the terrorists. But, we are led to believe, they are deluded. The terrorists are not the problem, they are! How ironic. How sad. Good drama, irresistible action.

We need this to make the movies, no doubt. But what is the implied solution? It’s obvious. Put the good guys in charge – the guys that are not deluded or corrupt. As Lord Keynes assured us, it is not government per se that is the problem. It is that the wrong people are in charge. You don’t see movies along the lines “the road to hell is paved with good intentions” when the good guys are in charge. No wonder Keynes won the debate. 

A Behavioral Approach to Development Economics

|Peter Boettke|

 

What actually is the behavioral approach? I have suggested that behavioral can be understood as an opening up of the strict rational choice model.

But in this lecture, the term is discussed in the context of the evolution from policy evaluation to program design. Though note that the reason why we engage in designs is because the existing programs when evaluated turn out to fall short. And why are the existing programs failing? Because of incentive issues. And how do we study incentives? Rational choice analysis. So then we move on to design programs that are supposed to structure incentives. But when we construct designs, people don't actually behave the way we designers thought they would. And we get this disjoint between design and behavior time after time. So what do we do? We design the system better to take into account underlying behaviors and structure the system to "nudge" folks to do what it is we designers want them to do.

This is a very clear cut lecture and reflects a thoughtful and interesting mind. I enjoyed this discussion, but I believe all of those who think about behavioralism should read Vernon Smith's Nobel Prize lecture on the difference between ecological and constructivist rationality (and Gerd Gigerenzer's Rationality for Mortals) and then read backwards to an older essay by James Buchanan, "Natural and Artifactual Man." Both essays in their own way, push the argument that choice is individual and contextual and not abstract. Our decisions are based on our subjective assessment of the trade-offs we face in pursuing our subjective desires. And yes, we have problems of self-control and self-delusions, but we also respond to incentives even in these areas. And, moreover, there are no doubt issues associated with stated intentions and actions pursued, and there are issues of a disjoint between stated intentions and outcomes realized.

Good economics has to look at not only immediate actions, but also the indirect results of actions pursued. The lecture has a great slide which contrasts Spock with Homer Simpson, and then flashes a picture of Brad Pitt when he was wearing a rather unattractive beard. This was to reflect that human choosers are neither perfectly rational nor completely foolish, but instead capable but fallible human choosers. I think this is right. But it is also the model of man one reads in Adam Smith and David Hume, and also one reads in Ludwig von Mises and F. A. Hayek.  In fact, I think one would benefit greatly from reading the first 100 pages of Human Action, not with a focus on the defense of deductive logic and its role in praxeology, but instead with a focus on the nature of choice and what is required for a human chooser to the center of analysis.  Along these lines, I think the best recent work is Richard Wagner's Mind, Society and Human Action.

Mario Rizzo is currently working on the question of rationality as well as a critique of variants of the behavioral economics that underlies much of the discussion which in this lecture is viewed as "design principles".

Did It, or Didn't It ...

|Peter Boettke|

Work ... fiscal stimulus that is.  Many studies have been released that claim the fiscal stimulus programs that have been pursued in the US since 2008 have not worked.  I tend to side with those studies because of my priors.  But there are alternative studies, and some claim that the stimulus has indeed worked.  Perhaps the reasoned debate over this should be carried on in a reasonable fashion.  See this Washington Post blog post and the linked to studies that argue that stimulus has in fact worked.

If you are a critic of fiscal stimulus programs, then what is your criticisms of these studies? What has been omitted in the analysis that leads them to conclude it works, while you still insist it didn't work?  Assume for sake of argument you have no ideological priors about "big government", and you simply want to look at the full array of costs and benefits of the programs pursued, what would your argument be?

This by the way is connected, not in the negative way that some may want to imply, is the reason I have used the old phraseology of the "economics of illusion".  And in the context that I have used this phrase it is about short-run and long-run, and in particular about fiscal policy and the shifting of the burden intergenerationally.  Starting in 2008, I stressed the need for analysts to re-read Hayek's Tiger by the Tail and Buchanan and Wagner's Democracy in Deficit.  I do think there are issues associated with crowding out, and even deeper issues associated with who gets the benefits of government stimulus programs (hint: they don't pass the generality norm rule for government policy), but the bigger issue is the long-run costs.

Since 2008, we have engaged in "triage economics", and while the medicine applied may have provided some short-term relief, the long-run costs need to be taken into account.  This I fear, they often are not. If you trade-off long-run growth for short-run relief, then you may very well be engaged in the sort of "fiscal child abuse" (to use Kotlikoff's phrase) and the embracing of the very "juggling tricks" that Adam Smith warned about so long ago as the natural proclivity of governments ancient as well as modern.  Stressing these points in economic analysis is not ideological, it is however recognizing that one must always put the political into political economy if you want to have a full analysis of the problem under examination.

Public choice is not a footnote to serious economic analysis, it must be at the core of any analysis that seeks to understand economic policy decisions and consequences.  Economic policy, as Miltion Friedman stressed in his review of Abba Lerner's Economics of Control, does not take place in a vacuum, and it is not designed by Edwin Cannan's Inca God who is omniscient, benevolent and omnipotent.  Public policy emerges out of the political machinations of real life and blood human beings (fallible yet capable as they are) who interact with each other in real institutional environments (historically contingent as they are).  This process of political decision making has costs and benefits that must be accounted for if an analysis of something like fiscal stimulus is going to strive to be complete.

Anyway, I think it is important for a reasoned debate in economics that individuals who are engaged in this debate serious be able to do what is done in the blog post linked above.  Understand the studies, not just their conclusion, but the way the authors reached their conclusion and what might be potential problems with their reasoning.