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« Stiglitz on the Economic Malaise The Plagues Europe and the US | Main | Claudia Goldin's Presidential Address to AEA January 2014 »


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No comments yet? Here are some on Kuehn's article off the top of my head. I refuse to put too much into critiques of Hayek when it's obvious the critics have put so little effort into understanding Hayek.

Hayek’s critics tried to understand his theory through the lense of equilibrium analysis. Clearly that is not possible. I have read a great deal of criticism of Hayek and for the most part my impression is that the critics may have “read” Hayek but never understood him.

Kuehn: “Hayek’s macroeconomic dynamics are evocative of a Rube Goldberg contraption…”

Milton Friedman called Hayek’s “Pure Theory of Capital” incomprehensible. I thought it was brilliant. I have often said the ABCT is too difficult for most PhD economists. I have to agree with Mises who said Friedman was a good statistician but he was not an economist.

Tullock: “I cannot recall the interest rate even being mentioned in any of our discussions of production matters.”

Hayek makes clear in “Profits, Interest and Investment” that businessmen do not pay attention to interest rates. I’m surprised Kuehn never sees that after citing the book. Businessmen follow profits. Hayek shows that reducing interest rates increases profits to be made in longer term investments, such as fixed equipment.

However, one of Hayek’s main points in PII was that the Ricardo Effect would happen even if the banks or central bank did not raise interest rates. Consumer price inflation would make labor cheaper relative to the sales of the company that employed them, not to other consumer goods as Hayek’s critics wrote. The cheaper labor would make investment in short term, labor intensive projects far more profitable. Businessmen would put off buying capital equipment in favor of labor intensive methods. The Ricardo Effect is little more than the capital/labor production possibility frontier taught in standard micro.

Kuehn: “So why are they fooled into building an unsustainable, distorted capital structure in the first place?”

Very few are fooled. Hayek’s point is that the profits available because of low interest rates are too tempting. Some cannot resist the temptation and will assume they can dodge the bullet. If none succumb to temptation, banks will keep reducing rates until someone takes the bait. Several papers have been done on the fact that low interest rates encourage greater risk taking.

And Hayek’s theory does not require every last businessman to do the same thing. Most businessmen weather recessions very well. But it only takes a few, and only in a few industries to cause a recession.

“Cowen notes that since the economy is operating at capacity any increase in capital goods production has to come at the expense of consumer goods production.”

Cowen just demonstrates his ignorance of Hayek. Hayek and all Austrian economists insist that even at full employment greater consumption and investment take place at the same time. That becomes possible because of capital consumption, a well established phenomenon during the boom. However, in PII Hayek shows how the theory works with high unemployment as well.

“Recall that the upper turning point occurred precisely because of this tension between consumption and investment.”

No, not at all. The upper turning point happens because of the Ricardo Effect, the trade off between capital and labor investment, not because of the “tension between consumption and investment.”

“A correlation between the depth of a recession and the height of the subsequent boom would strongly imply that recessions are the consequence of a shock that had nothing to do with the preceding growth period, and that the recovery was just a reversion of the economy back to its stable growth path.”

Keynes assumed that recessions are random events and all his followers have done the same with no evidence to back it up. Friedman’s little regression trick may imply what he suggests, or it may imply a lot of other things. He just lacked imagination.

“Friedman’s simple empirical exercise offers the greatest blow to Hayek of all the criticisms discussed here.”

As I pointed out above, Friedman admitted that he could not understand Hayek’s theory. I fail to see why Friedman’s regression is so devastating. If I remember correctly, Hayek proposed proportionality between the boom and bust based on the size of the expansion of the money supply during the boom, but ceteris paribus. Since ceteris paribus never holds, many things can distort that proportionality in the data. And I wonder if Friedman was a victim of what McCloskey calls the tyranny of statistical significance?

As for the empirical research, the work of Borio at the BIS provides empirical confirmation of Hayek’s work and the ABCT in general. Borio was among a list of prominent, non-Austrian economists provided by Boettke on his blog who offer empirical support for the ABCT. I’m surprised Kuehn didn’t consider them at all.

The interesting thing about the ABCT is that it began with the observations of Cantillon about money, investment and business cycles. The Manchester school and other classical economists noticed the same things. When credit expands, businesses in the capital goods sector invest more than those in consumer goods. Unemployment and business losses are higher among capital goods industries in recessions than in consumer goods. As Hayek wrote, the data may not be available, but some things are too obvious to require data as support.

I would like to see a similar treatment of the empirical evidence for Keynesian econ. I have seen a lot of studies that assume their conclusion, but no real test of the empirical data.

“Although a large recession did occur in 1980, it is widely acknowledged that this downturn was deliberately (i.e., exogenously) caused by Paul Volcker at the Federal Reserve, and that it was not the result of any endogenous tendencies in the economy.”

This is clear evidence of Kuehn’s lack of understanding of the ABCT. Hayek wrote in “Monetary Theory and the Trade Cycle” that the boom may end because banks fear rising inflation and raise their rates. Austrians have always insisted that this is a frequent cause of the turning point. But if the Fed doesn’t raise rates the recession will happen anyway because of the shift in profits to the consumer goods industries.

“Determining the real value of federal funds rate is trivial…”

No it isn’t. Of course one can subtract the cpi from the nominal rate. That is trivial. But the cpi tells us very little. Rapid increases in productivity can prevent cpi increases in the face of rapid monetary expansion. Hayek et al mentioned that as a feature of the roaring 20’s. That makes the calculations of real rates meaningless unless one wants to adjust for productivity increases as well.

“…who use data on inflation and output to determine the interest rate consistent with stable prices and the economy operating at its full potential.”

I doubt seriously that Hayek or Mises would accept that as a proxy for the natural rate of interest. In Hayek’s mind the natural rate had no connection to price inflation. In fact, many Austrians and critics are guilty of taking the quantity theory of money too literally, as Mises wrote.

“Low interest rates do not always indicate loose monetary policy if they are consistent with time preferences.”

I’m not sure where Kuehn gets this obsession with comparing monetary policy with time preference. I haven’t seen it in Hayek and Mises. Time preference is nothing but an explanation for the origins of interest. It is only a component of market rates and the natural rate. Other components include risk, profit and productivity.

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