The fallacies of Cowen and Krugman are of the most basic sort — errors
only made possible by men captured by a deeply false conception of
"science", and hence a pseudo-scientific capital-free, causally impossible, aggregate "modeling" approach to the macroeconomy, rather than a causally real relative price / heterogeneous capital ordering process approach, just as Hayek explained in his Nobel Prize lecture.
Here is the full article. I thank Bryan Caplan for the pointer.
Addendum: Angus comments.
So this means you understand the criticism?
My apologies for the snark. I really am frustrated with the low level of debate.
And if truth be told, I’m a purchaser of books by Tyler Cowen, and I’m a regular reader of his blog.
So it’s pretty clear my beef with Tyler is directed at his macroeconomics, and not so much his micro or his ability to explicate economic concepts.
Well, we can’t all be perfect. Though I strive for excellence in my criticisms of Tyler. Now I have the template.
Although I thought the “Tyler Clown” part was better. I just dig calling people clowns.
Sorry, but is this some sort of post-modern critique of the Alan Sokal variety?
The thing that confuses me is why Tyler is linking to Greg Ransom’s post as the criticism…
I assumed it was because Tyler read my article yesterday. Surely he is saving it for the December 31st, “The best criticism of me I’ve read all year” post.
And Tyler, again, what I cannot fathom is why you are citing high consumption and high investment as embarrassing to ABCT. They are necessary components of the story. The boom would be sustainable, but for that conjunction. Right? So maybe the story is dumb, but why do you keep claiming that this feature hurts it?
And note that is not last minute excuses on my part. Garrison’s PowerPoints clearly drive home the difference between a savings-induced sustainable expansion in the Hayekian triangle, versus a central-bank-induced UNsustainable expansion. See how the two ends of the Hayekian triangle got tugged in the Fed version?
Once again for clarity: Tyler is saying that the Austrians can’t explain how higher-order investments go hand-in-hand with increased consumption, whereas his theory (Tyler’s) of real wealth can explain it. But I’m saying no, it’s the other way around: If the boom were financed by real savings from Chinese etc., then it could have continued forever. That would have been normal Solow growth.
Ah, but if the boom is (partly) based on an unsustainable increase in consumption and investment which is not funded by real savings, THEN you understand why a crisis eventually occurred.
(Really, I realize Tyler wrote a whole book on this, and I am totally ready to apologize if I’ve been insane the last week. But I don’t think it’s me.)
It seems to me the Austrians are an agenda in search of a theory. I don’t see Krugman that way at all, or any of the ‘liberal’ (i.e., truly moderate) economists. Folks at Berkeley and Princeton spend all their time thinking about how their theories might be wrong, searching hard for the clear testable implications, and eating a big bowls of crow when their theories are proven wrong. Brad Delong does this extremely well. For a leaning libertarian, Cowen does a decent job of it, too.
But the Austrians? Or even, these days, the Mankiws, Beckers and Hassetts of the world? They have quit economics as a science and are now selling snake oil. To have proven their scientific credentials they would have had to have eaten a Holy mountain of crow. They didn’t.
Facts have consequences…
mike, I think the problem is that there don’t seem to be many serious criticisms of Austrian capital and business cycle theory. Austrian claims are often ignored rather than criticized, or criticized wrongly (as Tyler does).
There is the capital reswitching criticism, which sounds valid to me, but it probably isn’t fatal to the theories. I would love to see an Austrian answer to that.
What puts most people off of the Austrians is that the typical discourse on blogs such as these (or on political forums where Ron Paul adherents and similar armchair Austrian fanboys congegrate) sees the Austrian proponents assuming the mantle of ultimate truth. Not only is everyone else wildly wrong, the Austrians are if not infallibly correct then the “clearly most right” of the bunch. It doesn’t matter whether the level of debate is lofty or mud-caked, it’s still the same grudge-laden attitude dispensed from atop very high horses.
mike, Murphy’s piece was attempting to illustrate how there could be co-movement in consumption and investment. If you’re looking for evidence that our current crisis is an Austrian business cycle (and all Austrians I’ve read believe there were factors at play other than low interest rates) you’d need to look elsewhere.
Greg, thanks, I’ll give it a read.
I laughed when I was this post under the rubric “sports.” Come on, Tyler!
What was the effect of the monetary policy between 2001-4 on the housing bubble? Keep in mind that the CRA and related were passed before. I think that is the question raised by Tyler’s comments here.
How about a compliment for balance:
You sure take criticism very graciously.
mike,
you don’t even sound like you’re attempting to understand. You’re simply trying to share a preconceived and general opinion you have of Austrians regardless of what’s actually being discussed.
What Greg and Bob have done in their respective articles is DEMONSTRATE why what Tyler and PK said was wrong. They did it. It’s right there for you to read.
I’m no economist and don’t claim to be. BUT, based on what I have taken an interest in reading concerning Austrian Economics, I can just say that both Tyler’s and PK’s repeated critiques of ABCT always strike me as overly simplified, cursory, hollow and forced into some methodological framework that ignores the deeper implications and inner workings that underpin the theory. IOW, it’s as if they are critiquing a shallow and flawed understanding of the ABCT as would be explained by some “arm chair Austrian” non-economist…but never as it is presented by a real economist who truly understands Austrian Economics.
Besides, PK actually knows very little about Austrian Economics…if much at all. Krugman’s understanding of it strikes as what he may have heard from someone who heard someone talking to someone about someone who read an article about it once back in the day. Very superficial. And then Krugman forces what little he has picked up along the way into his way of understanding economics…which isn’t really that honest.
I’m really not sure where you get the idea that “the facts” refute Austrian Economics either.
I guess Angus has accurately assessed the quality of that idiot Ransom. Incidentally, Ransom used to have on his info details the delightfully absurd claim that “is a world recognized authority on the work of FA Hayek”. I did not realize that publishing zilch went hand-in-hand with being a world recogized authority.
1) Guess what?
These acrimonious debates and angry finger-pointing between Austrian devotees on one side and Chicago-school and other libertarians on the other remind me of nothing short of the similar searing recriminations and charges of apostasy and heresy that rattled Marxist theorists after the collapse of the Soviet Union and world Communism in 1990 and 1991. As for a conservative New Keynesian like Gregory Mankiw, he’s beyond the pale, ideologically speaking . . . not just a heretic, but an outright traitor according to at least one view expressed here.
……
2) No point in my delving into the Austrian theory — is there really just one composite Austrian economics theory of the business cycle? — because no matter what others offer by way of criticism, it will be defended against by means of citing this or that aspect or auxilliary conditions as the wayward cause or (if Austrians did statistical modeling) as confounders.
…..
3) Frankly, I myself don’t care one way or another.
Thus hard-core Chicago-school libertarians will defend their theories with the same vigor . . . the current financial meltdown, like the financial upheavals of the 1980s and earlier in this decade all, ultimately, the fault of some government program some where, some time — even if, as I’ve read at a couple of libertarian web sites, it some regulatory rule passed in the late 1970s.
Just as, in Marxist circles — when they weren’t busy accusing one another (Leninists, Stalinists, Gramsci-cultural-hegemony-converts, structural Marxists: the welfare state temporarily holding off inevitable revolution; Maoists; Guevera-ists and Castroites; and what have you — nothing could really refute their core beliefs. Even as, at least in China — where the CP big-shots were moving toward statist capitalism modeled on the South Korean forerunner in its military-controlled days — the ideologues kept and keep telling everybody it’s really Marxism-Leninism updated for the global system.
…….
4) As far as I can tell, fractional banking and a private central bank go back to the 17th century. And guess what further? Before that period, all economies of the world were still stuck in a Malthusian trap. Somehow, the western world and East Asia and for that matters parts of Latin America are far richer — far, far richer in the democratic, technologically advanced ones in those regions — than before fractional banking and central banks were ever conceived.
What does seem clear to me — leaving aside all theoretical huffing and puffing — is that since we started deregulating our financial system in the early 1980s, and, worse, the regulations that existed were ignored or violated by the SEC and Fed in the Bush-W era, we have suffered one huge financial upheaval or crisis after another.
….
5) At least the apostate Tyler has show himself open to this possibility, enough to condemn him to an auto-de-fe and eventually symbolic burning-at-the-stake, right?
Michael Gordon, AKA, the buggy professor
I’m no economist and don’t claim to be. BUT, based on what I have taken an interest in reading ….
I’m not either, I troll around here and there looking for cogent arguments that confirm my biases and help me rationalize my prejudices to bored victims.
Consequently, Tyler is only right when he’s stridently opposed to federal intervention and harshly skeptical of panic-inducing hysteria from our bureaucrats. He is always wrong in his equanimities and mild musery.
Professor Michael said
“What are Mr. Murphy’s testable implications?
Here [pdf] is a forecast I made in July 2007, based purely on Austrian business cycle theory. Everything I said in there is true, except long-term interest rates have not risen because I was banking on inflation expectations, not a panic …”
Stop! Stop! you’re killing me!
For those who are interested the pdf is an analysis of 10 year treasury notes. From the summary;
“In the next two to three years, we expect to see
10-year rates rise 300 to as much as 600 basis points, ”
So I guess when one of your students says I predict that I will study this weekend and instead goes to daytona beach to party you say “effin A man, that proves the crap out of that hypothesis!”
For those who are interested the pdf is an analysis of 10 year treasury notes. From the summary;
“In the next two to three years, we expect to see
10-year rates rise 300 to as much as 600 basis points, ”
So I guess when one of your students says I predict that I will study this weekend and instead goes to daytona beach to party you say “effin A man, that proves the crap out of that hypothesis!”
Huh? I acknowledged that I got the Treasury rates wrong. You even quoted me acknowledging that.
I got the direction and timing on the other major issues right: short rate drop, dollar plunge, stock plunge, recession, inflation up, and real estate plunge. (Some of these were already in motion when I wrote, I grant you.)
Bob Murphy;
Let me give you a hint about how to present your ideas. If you write a paper with the title:
“My opinion about the who Obama is going to pick for VP”
and you carefully elucidate out your political concepts and then put into the summary (in bold) that Obama is going to pick Hilary, then don’t quote this paper to prove how smart you are.
The really clever thing to do is not to mention this paper again (except ironically to show humility). Don’t say, yeah I got the main point wrong but look at all the other things I said. Especially don’t reference this paper in an argument to try to prove a point.
Trust me, you will go through life with sarcastic people like me getting a bit of a laugh at your expense. Haven’t you had any smart aleck students to teach you this lesson?
Virgile writes:
“I’m no Austrian, but it would be nice to see Tyler respond to Bob Murphy’s article.”
What I’d like to see is Cowen (and Krugman) respond to the explanatory strategy Hayek actual presents, rather than a confused understanding of a false account of something Cowen labels “ABCT”.
IT AIN’T HAYEK.
I have every right to be angry with economists who present false attack against a theory they don’t understand.
Cowen is attacking something he himself invented after reading a bit of Rothbard, not something that exists in the work of Hayek. And he should tell everybody that.
Trust me, you will go through life with sarcastic people like me getting a bit of a laugh at your expense. Haven’t you had any smart aleck students to teach you this lesson?
And trust me, if you drop the sarcasm and try to learn from professors who know infinitely more than you on various topics, you will end up a lot more informed.
(BTW I am no longer a professor.)
Bob Murphy,
Sorry about implying that you were a professor. If you think I am rolling in or slinging mud I apologize. I agree, you have a while to go on your prediction. Are you still sticking to them?
“I’m not necessarily sold on interest rate manipulation being the cause of a business cycle.”
The KEY thing to know is that this is NOT the core of Hayek’s cycle theory — it’s a contingent explanatory fact identifiable in some but not all cyclical phenomena.
IT’S NOT A NECESSARY ELEMENT OF THE THEORY, as Hayek DIRECTLY points out.
The key thing is systematic disorder across the time structure / capital structure of the economy, which can be caused by things other than the interest rate policies of a central bank.
Tyler doesn’t get this — part of my best guess as to why is because Tyler hasn’t much studied Hayek — he read some Rothbard and went to town attacking a crude version of Rothbard.
Tyler has never really engaged Hayek.
That’s my opinion, and I have yet to see evidence which might persuade me otherwise.
Is not a key question whether people changed their minds about risk or were misled? If misled, who misled whom?
Sorry Tyler, your book is more than a buck per page on Amazon, can’t do it.
Another question I’ve had. We seemed to hit the ceiling on raw materials cost. No, if I’m a manufacturer in a competitive business and I find a point in my growth where I view further growth in the economy as instigating hyper increases in my costs, I realize that is unsustainable so that gives me a rationale to stop worrying about my competitor outgrowing me. So, I can take a breath, do some retrenching, pay off some loans, take some of my production off-line for maintenance, etc.
Alternatively, if we don’t hit that ceiling on raw materials, I’m scared as hell that my competitors are going to keep investing in growth.
It seems there’s a combination of both misleading and retrenching going on, and to me, it’s the Keynesian argument that loses most in this scenario. When you’ve found the ceiling for raw materials cost, and your operations aren’t as indefinitely profitable as you thought they were, do you really want to “boost aggregate demand” and possibly waste resources just to keep plants running?
how does the sushi story generate positive co-movements in investment and consumption?
Net investment = f(K.L)-C-delta*K
In the sushi story, there used to be 25 workers taking care of capital depreciation by repairing nets & boats (the delta*K above) – when 20 of those workers are reallocated (some to fishing and rice farming) doesn’t net investment fall? Only 5 workers are allocated to investing in the new outboard motor.
I must be missing something
What is the real-life counterpart of Krugman´s bad advice in the (funny) sushi narrative?
I am asking because it sounds like something really exogenous. If the whole thing got started by something happening inside the economic system, would we see the comovement? Maybe yes, but I am not sure.
By the way, here is another Hayekian theme for you guys: if risk was indeed measurable as those new financial instruments assumed, would market socialism be possible? And, since we now may assume they are not, can we conclude that the (market) socialist planner’s mistakes can be reproduced by the private sector? If the answer is yes, should the state have intervened to stop socialism?
hey presto, good to see you back in action…
-kp
What does seem clear to me — leaving aside all theoretical huffing and puffing — is that since we started deregulating our financial system in the early 1980s, and, worse, the regulations that existed were ignored or violated by the SEC and Fed in the Bush-W era, we have suffered one huge financial upheaval or crisis after another.
Before the early 1980s everything was good low unemployment low inflation. I am being sarcastic.
As Bob Murphy points out, Tyler Cowen, in January 2005, wrote:
If I believed in Austrian business cycle theory
1. I would think that Asian central banks, by buying U.S. dollars, have been driving a massive distortion of real exchange and interest rates.
2. I would think that the U.S. economy is overinvested in non-export durables, most of all residential housing.
3. I would think that we have piled on far too much debt, in both the private and public sectors.
4. I would think these trends cannot possibly continue. Asian central banks may come to their senses. Furthermore the U.S. would be like an addict
who needs an ever-increasing dose of the monetary fix. This, of course, would eventually prove impossible.
5. I would think that the U.S. economy is due for a dollar plunge, and a massive sectoral shift toward exports. Furthermore I would think it will
not handle such an unexpected shock very well.
That’s a remarkable list. It looks like something written after the fact rather than before.
I have a couple of questions:
Bob Murphy, as an Austrian business cycle theorist, can you confirm that Tyler’s perception
of the theory is accurate as far as it goes and that these would indeed by commonplace predictions
among Austrian business cycle theorists?
Tyler Cowen, was it your intent at the time, to assert that you did not believe these outcomes
were likely? Or is instead that you believed in all five of these outcomes but your belief
had nothing to do with Austrian business cycle theory, and instead, you were simply pointing out
a remarkable convergence?
Luis:”In the sushi story, there used to be 25 workers taking care of capital depreciation by repairing nets & boats (the delta*K above) – when 20 of those workers are reallocated (some to fishing and rice farming) doesn’t net investment fall? Only 5 workers are allocated to investing in the new outboard motor.”
Prices.
The investors in the scheme, in this case the people of the island, believe that the 5 workers they have allotted to the task will perform the function of the previous 25. In the long term they may be right, however the crisis comes before then.
To put things in terms of normal Austrian theory. There is no “unit of capital”, Piero Sraffa demolished the notion. Capital is heterogenous, all that can be said about certainly it is that it has a money price. A tractor, plough or warehouse has a price to a community of buyers. This doesn’t tell us how much productive capital there is overall.
If money is created and given to Fred then others in an economy don’t know that. They continue their plans as though prices will move as they have in the past, as does Fred. Fred is now rich and can afford to make more long term plans. As a result plans across the economy become more long term.
This results in bidding up the price of capital goods. That doesn’t mean though that the aggregate price of those capital goods is the same as their utility. If the number and composition of capital goods stayed the same then they would still be bid up.
Tyler: “There is of course a literature on capital maintenance expenditures over the business cycle. The countercyclicality of maintenance is a) evidence that real interest rates are really not the driving forces behind business decisions over the cycle (if so maintenance would be favored over consumption), and b) not big enough to account for the more general comovement in other sectors — including new investment and consumption — during the cycle. I discuss many other related issues in my book *Risk and Business Cycles*. There are *possible* ways to get comovement on the upswing, but it’s far from obvious that any of them work out in quantitative terms.”
Yes, capital consumption isn’t necessarily a problem.
However just because there is comovement demonstrates nothing. Money creation distorts the price of investment goods just as it distorts how they are used.
I came away from Murphy’s article with the impression that the essential distinguishing claim of ABCT is that there is capital consumption when output is above potential. If that is the case, one could take an Occam’s razor to all this stuff about stages of production and intertemporal complementarity. In terms of modeling, you could create a hangover model with a slight modification of the Solow equation:
That is,
(1) K[t]= K[t-1]+ s[t-1]*Y[t-1] – alpha*K[t-1]
(K is capital, s is savings rate, Y is output, alpha is rate of depreciation)
would become
(1a) K[t]= K[t-1]+ s[t-1]*Y[t-1] – alpha[t-1]*K[t-1]
where
s[t]=negative function of the real interest rate in period t
alpha[t]=positive function of the ratio of labor to capital in period t
Incorporating these equations into a standard IS-LM-AS type framework would yield the desired result of having hangovers after an inflationary period. I’m not an economist, but if anybody is reading and wants to co-author a paper like this, let me know. I think it could be fun…
OK there have been a lot of posts and I can’t respond to everything, but let me give a very cursory attempt:
* meter and RobbL: I’m “cool” with you guys; maybe I sounded mad earlier.
* As far as what I missed in the Treasury forecast, it was the global panic. I thought there was going to a bad recession, a falling dollar, and rising US prices, and Fed cuts in order to deal with the recession. But I didn’t expect everyone to poop his pants and rush to Treasurys. In fairness, I don’t think anybody quite saw that aspect of all this. Ironically, the people who predicted low long-term bond yields were right but for the wrong reasons: they were saying everything was great, the Fed had inflation under control, blah blah. In contrast, the alarmists like Peter Schiff and (much later) me, were warning of high bond yields because we expected massive inflation from the damaged US economy. As far as I know, nobody before August 2007 was saying, “The US economy is in terrible shape, but things are so bad in fact that there will be a run on the financial system and this will push up Treasury prices for at least a year.”
* Tyler’s 2005 list of “ABCT predictions” is more specific than what standard ABCT would say. It is certainly consistent with it, but Ludwig von Mises in 2005 need not have agreed with Tyler’s list. ABCT really just says that the artificially low interest rates led to malinvestments, which would require a recessionary period to cleanse out the system.
* Someone had a great point about whether investment actually went up in the sushi story. You’re right that it probably didn’t go up in reality, but (as someone else tried to explain) the point is that the islanders would have thought it went up. I.e. if they weren’t paying attention to the deterioration of their boats and nets, then the capital base was constant on that front. And then, they also thought they were gaining the ingredients necessary to make gasoline and motor oil. So in that money-less economy, if we define “net investment” as an increase in the capital stock, then yes they thought they had net investment occurring while consumption increased too.
* Someone wondered why we don’t just model this as an overconsumption theory in a Solow model. It’s because in a Solow model, the Austrian idea of malinvestment in impossible. In other words, the Austrians aren’t just complaining that the “wrong” interest rate leads to a reduction in welfare, because of the altered pattern of intertemporal consumption. On the contrary, Austrians say that during the boom, investment projects are started that will later have to be abandoned.
* Keep in mind that I was wrong in my article to imply that the Austrian theory relies on capital consumption. Mises stresses the point, and so does Garrison, but not all Austrians do. In fact Hayek himself (at least in some portions of his earlier work) thought that higher aggregate consumption was physically impossible in the early stage of the boom, for the very reason Tyler does too.
* Final point: My article was NOT supposed to be an illustration of the Austrian business cycle theory, so much as an illustration of an unsustainable boom fueled by capital consumption. Its purpose was to show that Krugman and Cowen’s sweeping assertions were wrong; i.e. it was a counterexample to their claims.
Thanks for the replies. I think in your moneyless economy, all you have to work with is the allocation of workers either to the production of consumption goods or investment goods. Capital maintenance (repairing nets) is a flow investment in the capital stock. In your story, investment certainly falls ‘in reality’ durinng the consumption boom. Bob I take your point that the islanders may believe investment to have risen, but that moves us into explaining business cycles by asserting errors (irrationality). I’m actually pretty sympathetic to that … I think capital mis-allocation probably does happen, cyclically, and is important, but I don’t know what’s Autrian about that argument. I’d very much like to think up something that could falsify such an explanation.
As for explaining co-movement in I and C by appeal to increased prices for I, well for a start if that’s the explanation then the sushi story is not helpful. And at first glance that explanation raises as many questions as it answers – if the price of investment goods rises, whey doesn’t investment (in terms of quantity) fall? You can say capital is heterogenous, which is a notion I imagine Solow would have no beef with even if his famous model doesn’t cater for it, but where does that get us? Does it make it impossible to talk about quality adjusted quantities of capital?
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