Ebeling on the virtues of Austrian and the fallacies of Keynesian Macroeconomics

Dr. Richard Ebeling posted a piece on the Cobden Centre website on 10th January contrasting Austrian with Keynesian economics. 

On the one hand Ebeling criticises the widely accepted `Keynesian´ approach to macro economics on the grounds that it deals with aggregate quantities (average prices, average wages); quantities that "have no real existence", using an approach that overlooks all the individual prices and wages of specific products and skills. On the other hand he praises the 'Austrian' way of looking at macro economics (as expounded by von Mise, Hayek, Rothbard and others) for its refusal to consider such aggregates, and its insistence that the economy will adjust itself far better if left alone than when tampered with by ill-informed government intervention.

I think it is ridiculous to view these two approaches to macroeconomics as though they are in conflict; as though one must be `wrong´if the other is `right´.

Of course there is an average wage and an average price level. They do not exist, but they are determinable quantities.  Keynesian theory does not interfere with the prices of individual items nor the wages of particular operatives, any more than the Austrian theory does; they are of course left to market forces, by both theories. If the average price level rises (or is raised) a few percent relative to appropriate wages, individual productions will become profitable one after the other in the same general(#) way on the Keynesian theory as with the Austrian theory.

The Austrian theory does not require aggregates because it is not going to advocate any government interference. It is simply going to watch while the business cycle works its way through the economy, bankrupting firms and depriving families, until entrepreneurs once again find that there are too few skilled workers, and start to hire `foreigners´. It explains, but does not intervene. 

Non-intervention is better than bad intervention, and that is the virtue of the Austrian school. But is it better than good intervention? I think not, and that is the weakness of the Austrian school. I think that it is morally impossible to sit back and watch capitalism at work. I mean impossible for a moral conscience. It is too easy for the wealthy to exploit the poor, the clever to cheat the foolish. And I think western civilisation has come to the same conclusion over the last thousand years, instituting taxes and charities, encouraged by a predominantly Christian view of heaven and hell.

But if that is the weakness of the Austrian School, what of its strengths? And do governments effect more harm that good? 

It is undoubtedly a weakness of democracies that they find it hard to raise sufficient revenue in taxes. Who, for example, campaigns for votes by offering to raise taxes? (Only in Scandinavia where, one suspects, it is for predominantly climatic reasons.) So, I suggest that the fact that governments seem to get it wrong more often than right, may not be solely down to their (governmental) stupidity. As for the newspapers and the voters, that is another matter, and I suspect that ignorance plays a considerable part.  I like to think that, since 1936 when Keynes published his General Theory, governments have, occasionally, mitigated the severity of the business cycle on the populations in their care, by providing relief, or work on infrastructural projects. 

However, tinkering with bank rate has its limitations, and I am not yet convinced of the benefits of quantitive easing, except benefits for the bankers, for I am skeptical of the extent of trickle-down.

(#  I realize that the order in which businesses become profitable one after the other will be slightly different when the price rise is general (as it might be if government intervenes) compared with the diverse price rises that pure market forces can devise. The Keynesian result will not be identical to the Austrian result.)

Shostak on The Importance of Theory

Shostak on 'The Importance of Theory'.

In “Fed confused about what drives inflation?”, Dr. Frank Shostak writes:

“The purpose of a theory is to enable to ascertain the definition of a phenomenon that is subject to investigation.
    The correct definition attempts to identify the essence of the phenomenon i.e. the key parts that drives the phenomenon.
    For instance, the definition of human action is not that people are engaged in all sorts of activities, but that they are engaged in purposeful activities – it is purpose that gives rise to an action.
    So when Tarullo states that Fed policy makers do not know the causes that drive inflation he basically says that Fed policy makers have not as yet established the correct definition of inflation.
    Is it then valid to be practical, as suggested by Tarullo, to focus only on the data to understand what inflation is all about? If Fed policy makers respond to changes in price indices without establishing what drives these changes this runs the risk of making things much worse.”

My literal translation (into English).

The reason for propounding a theory is to make possible the definition of the phenomenon under investigation. A correct definition identifies the essence of the phenomenon, i.e. the forces that drive the phenomenon. For instance, the correct definition of “human action” indicates that activities are purposeful, not merely varied; for it is the purpose that gives rise to the action.

So, when Tarullo states that policy makers at the Federal Reserve do not know the causes that drive inflation, that is tantamount to saying that they have the wrong definition of inflation. Is it then valid to focus only on the data (as a means of understanding the ‘meaning’ of inflation)?  To react to change in the Consumer Price Index without understanding what is causing those changes could make matters worse. 

My Comment

I do not think the reason for propounding a theory is the one given, and I disagree with Shostak’s definition of “definition”, and (in addition) his definition of “human action”. But this nonsense is not germane, and perhaps can be safely ignored. I agree with Shostak that the Federal Reserve should try to understand the cause (or causes) of any current inflation. 

It may be that inflation indicates that something is changing; the volume of money, or of goods. An intelligent Government would try to identify what exactly is changing, and adjust for that. They should not merely obliterate the signal. There is a parallel in healthcare. Pain is a signal of something going wrong. An analgesic like paracetamol obliterates the signal but does nothing to identify precisely what is going wrong, and nothing to rectify the problem.

Dr. Shostak is angry about inflation because it robs value from those with positive bank balances. But there will (presumably) be others who like inflation because it gives value to those with negative balances, and those who create the money. 

But let us get back to the "importance of definition". Dr. Shostak writes:

"However, if we accept that inflation is about rises in money supply and not a rise in prices then all ........ can be easily explained.  It is not the symptoms of a disease but rather the disease itself that causes the physical damage. Likewise it is not a general rise in prices but rises in money supply that inflicts the physical damage on wealth generators."

Once again  I disagree. I believe that the money supply should increase as and when necessary, for example, when there is an increase in goods. 

But there is a quite different, and much more subtle argument in favour of a controlled low level (2%p.a.) of inflation. Is the Keynesian position not generally accepted that, for psychological reasons, an economy is more stable and more easily controlled when there is a constant low level of inflation? Do we throw out the "General Theory" and 8 decades of largely successful government for the sake of simple mathematics? I do not think the case is made, yet.  

Maybe we could agree that, as a type of covert taxation, inflation is a bit underhand. 

“Coppola Comment” Comment

“Coppola Comment” Comment

Frances Coppola is always an enjoyable read, enunciating good sense in lucid prose. But she can be teasing, as in her latest blog.

Growth:

     Like organisms, I believe economies can grow until they approach maturity, when they will enter a ‘steady-state’. It is neither possible nor desirable to grow for ever. By the way, GDP cannot be used as a measure of improvement unless corrected for devaluation of the currency, and for change in the population. True growth (in wealth) would have to involve either an increase in population or productivity (per worker), or both.  I cannot see why anyone should want a mature economy to grow.  No sane Briton could want an increase in the population (of Britain), nor an increase in the ratio of concrete to green-space, in Britain. There will (in Britain) be even less interest in the growth of economies elsewhere in the world. 

Inflation:

     I suppose inflation is (in essence) the willingness of some people (sufficient people) inside a currency zone to pay more for a standard item (or sufficient basket of items).  And I suppose this could happen if the items become more scarce, or if the currency becomes more plentiful. 

     I assume that the conventional aim of 2% inflation depends entirely on politics and psychology; not on economics. People are unwilling to accept a lowering of money wages. If government wishes to lower real wages (for whatever reason), that can be achieved most easily by fixing money wages and waiting for inflation (devaluation). In Japan, with a mature and stable economy, I cannot see why anyone could possibly want inflation, whether in the form of devaluation, or of growth.  (If Japan wanted inflation, I think that could be achieved, with a printing press.) 

Interest Rates:

     From Cowen, I read “Peter Olson and David Wessel write:

‘The natural rate of interest, also called the long-run equilibrium interest rate or neutral real rate, is the rate that would keep the economy operating at full employment and stable inflation’.”  When base interest rate was the only lever the Central Bank could pull, the Olson and Wessel definition probably made some sense; the central bankers spent their time sliding the lever up and down while watching their two indicators of success. Quantitive easing provides another lever for the Central Bank, and doubtless upsets the theory of ‘natural interest rate’.  Even without the complication of quantitative easing, it seems quite possible that the concept of Natural Interest Rate contains internal contradictions: [a] Full employment may not be ‘natural’. [b] Full employment, when achieved, might not be compatible with the interest rate required for stable inflation (unless stable inflation is used to provide a definition of “full employment”).

Coppola clearly knows all that, and in her blog is not so much dismayed, as laughing at the discomfort of the economists who were armed not with basic principles but with rules of thumb.  

What is Wrong with Macroeconomics

Macro Mess

     People complain that macroeconomics is a confused mess. It is said that macroeconomists disagree among themselves, that the government is pursuing the wrong policies, that the opposition is not mounting an effective opposition. 

     Diane Coyle in 2012 put the case in a well argued lecture (1), and again in a shorter, less formal, way in a passionate blog (2). Jonathan Portes, in his rebuttal blog (3), summarizes Coyle’s case succinctly as:  

a) "although macroeconomists will insist that there are known scientific facts, they do not appear to agree on what these are”,

b)" the discussion among macroeconomists is so shouty”,

c) "all economists need to do far, far better at explaining their work to the general public”.  

Portes partly rebutted each charge, but in doing so seems to concede each, in large part. 

     That was in 2012; but the argument persists. Last month ‘Unlearning Economics’ (4) weighed in against macroeconomists, and last week Simon Wren-Lewis rushed to his own defence in Mainly Macro (5). But now the argument brings in the extra dimension of politics. Both these bloggers assume ‘progressive’ means ‘distributing downwards the benefits of labour’, and is ‘good’, while ‘regressive’ means ‘reinforcing the power of capital’ and  is ‘bad’. 

     It seems rather pompous of me to join this learned debate, but I have a point or two of my own that I want to make. In my own field of expertise I have seen intellectual tribalism, and well understand a reluctance to grapple properly with alternative ways of rationalising the data. “Intellectuals”, my illustrious colleague often said, “seldom  concede; but they do eventually die”. Natural scientists can usually (in time) be shamed into testing their theories against data; arguments can only persist if both theories are able to rationalise the facts. Does this hard filter operate adequately in macroeconomics?

     However, much of the argument is occurring at levels less rational than the purely academic; between politicians, business men, media commentators, bloggers and the average voter. There are hidden agendas, and consequent confusion, not only about the means, but about the objectives of government policy. Are we trying to increase GDP, or actually trying to reduce taxes; trying to decrease unemployment, or secretly trying to increase it (to bring down costs)? Are we seriously trying to bring down the cost of housing when we ourselves have houses and are getting rather rich thereby, or are we trying to increase profit margins in the industry? Are we simply trying to win an election?  Even phrases like ‘fair taxation’ sow confusion, for some will think it means making the relative burden equal across the spectrum of wealth, while others may think it means we all pay the same absolute amount, like the 'poll tax'. 

     

     It alarms the laymen when they see professors of economics disagreeing (6) and calling each other idiots (7).  It is fair to say that the subject matter of the discipline is complex. But most cutting-edge academic work is complex, and effectively closed to the layman. Macroeconomics, however, is additionally hampered by a traditionally cryptic exposition. Keynes was obviously very clever, which enabled him to conceive the most convoluted and arcane pronouncements (8). Imagine the thrill of finding that your academic competitors do not see the relevance of IS-LM. You will need to explain it! (9), but not clearly enough to be understood; you do not mention what I,S,L and M signify, do not explain that the graph is rotated 90º and uses jumbled axes. (c.f. wikipedia, and https://www.youtube.com/watch?v=mTr2PVbbpxg). 

     Yet there is a simplicity in macroeconomics, as in most things, if you have a mind simple enough to see it. Suppose government wants businesses to produce more goods and employ more men, so that more people have more money and buy more goods. It urges the Bank to lowers interest rates. The people with money buy, those without money borrow and buy. The businesses borrow and build, take on workers, who in turn can now buy goods. Success! But what if interest rates are already near zero? And still people are not buying. (There is clearly no requirement for cash, no point in building factories, no confidence in the near future.) What does 'Marcoeconomics’ suggest? "Fiscal loosening”, says Krugman; but does he mean increasing government spending, or lowering taxes to leave more money in the people’s pockets, both of which increase public debt? (See Chick and Pettifor, 10). 

Now here comes the real problem. What does government do but cut Government spending, and flood the banks with ‘quantitative easing’. (Hadn’t we just established that it was not money we were short of but ‘demand’, and confidence?) The rich get richer, and the poor get poorer, and there is barely a flicker of a recovery. The bosses can invest in new plant! — but there is no point, as there are no customers, no demand.

It is not so much that ‘Macro got it wrong’ as ‘Macro got ignored’. But Macro did get it wrong, twice. It failed to get its point across to those who would have heeded. And in my opinion cutting taxes is not remotely as effective as increasing taxes and increasing government spending; it is merely easier. (See my “Tax and Spend”, 11).  There was no need to scare the public by increasing public debt; and therefore no point in advocating it. Crikey! 

References:

(1) https://www.bnc.ox.ac.uk/downloads/news/tanner_lecture_2012_text.pdf

(2) http://www.enlightenmenteconomics.com/blog/index.php/2012/06/a-macroeconomist-tells-me-off/

(3) http://www.niesr.ac.uk/blog/macroeconomics-what-it-good-response-diane-coyle#.WNkH0GU0mdE

(4) https://medium.com/@UnlearningEcon/no-criticising-economics-is-not-regressive-43e114777429#.iwfjl01sl

(5) https://mainlymacro.blogspot.co.uk/2017/03/on-criticising-existence-of-mainstream.html

(6) https://krugman.blogs.nytimes.com/2016/12/24/dont-blame-macroeconomics-wonkish-and-petty/?_r=0

(7) https://www.forbes.com/sites/timworstall/2016/12/25/paul-krugman-gets-his-recessionary-macroeconomics-wrong-again/#5cc30754701e

(8) http://occidentis.blogspot.co.uk/2014/06/keynes1.html

(9) https://krugman.blogs.nytimes.com/2011/10/09/is-lmentary/

(10) http://www.debtonation.org/wp-content/uploads/2010/06/Fiscal-Consolidation1.pdf

(11) http://occidentis.blogspot.co.uk/2016/07/tax-and-spend.html

Keynes1

The difficulty of Keynes's Style

    While greatly admiring the clarity and confidence of Keynes's thinking I am very critical of the obscurity of his style and the impediment that raises to a close reading of his important book: John Maynard Keynes* (1936), "The General Theory of Employment, Interest and Money" (readable online). Take (for example) the following from chapter 8.

"Since we are here concerned in determining what sum will be spent on consumption when employment is at a given level, we should, strictly speaking, consider the function which relates the former quantity (C) to the latter (N)."

The 'here' is mere pedantry. And the definitions of C and N are unnecessarily delayed. Given that, in English grammar, 'which' describes while 'that' defines, I conclude that JMK has a tendency to confuse the two. So try:

Since we are occupied in determining what sum will be spent on consumption (C) when employment (N) is at a given level, we should consider the function that relates the two.

    Another example of the that/which problem (from chapter 2):

"....; whereas they do not resist reductions of real wages, which [I suggest 'that'] are associated with increases in aggregate employment and leave relative money-wages unchanged, unless the reduction proceeds so far as to threaten a reduction of the real wage below the marginal disutility of the existing volume of employment."

    I submit that not all reductions of real wages are of the sort described, so the 2^nd clause is a 'definition', a necessary limitation, and not a 'description'. (But I do not claim to underatand "the marginal disutility of the existing volume of employment.")

    Take that obscure but important definitions in Chapter 2 — that of "involuntary unemployment". Unless you understand this you do not understand Keynes:

"Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. "

    Keynes's "would be" throws me, as it flouts the Humpty-Dumpty rule on conditionals ('If the number were greater the men would be unemployed'). Which men? No-one has been sacked, so are we talking about men currently idle by choice, who wish to become employed because of a rise in real prices, but who cannot find a job (except at a wage below the current)? (I do not see the force of this. Will not the classical school say that there is nothing to stop these men taking a lower wage (unless it be collective bargaining)?) 

    What is the 'aggregate demand for labour'? Does Keynes mean that the entrepreneurs are seeking workers? So, why does not the 'existing volume of employment' increase if there is both rising demand and supply? Are we merely talking about a time lag; the supply and demand for labour go up, but the jobs do not appear immediately? However, we all know that there are people seeking work during a 'depression', and we suspect it is because the entrepreneurs do not see a market for further product.

    I find (to my amusement) that people write books [ref. 2] about this important concept of the 'involuntarily unemployed', and the obscurity of Keynes's writing.

References:

1.  John Maynard Keynes (1936), "The General Theory of Employment, Interest and Money" (0nline at eth, Zurich.)

2.  G. L. S. Shackle (1983) The Years of High Theory: Invention and Tradition in Economic Thought 1926-1939.

--
Blog1:http://occidentis.blogspot.com/
Blog2:https://ianwest2.wordpress.com/
Blog3:http://cawstein.blogspot.com/