Reply to Juan Ramón Rallo on the Austrian Business Cycle Theory

A criticism of my points in the last post is available here:

“Seis malas críticas a la teoría austriaca del ciclo económico,” Juanramonrallo.com, 3 August, 2013.

The author is Juan Ramón Rallo, a PhD in Economics from the University of Valencia and a Masters in Austrian economics from the Universidad Rey Juan Carlos (Madrid). He blogs here.

Some responses:

(1) Juan Ramón Rallo’s first criticism is that the Austrian business cycle theory need not assume the existence of the unreal Wicksellian natural rate of interest. Thus Juan Ramón Rallo seems to agree that the natural rate of interest does not exist.

That is a fascinating concession. Why? It is tacit admission that all versions of the ABCT that do use the Wicksellian natural rate of interest are unsound. Unfortunately, it means that the versions of ABCT by Mises (1934, 2006 [1978]), Hayek, (1931, 1935), Rothbard (2004 [1962], 2009 [1969]), and Garrison (2000) and many others must be wrong, because they all use the natural rate. That is a devastating conclusion.

Indeed, it is the conclusion one must draw from the work of the Austrian Robert P. Murphy on the non-existence of the natural rate and the failure of Austrian attempts to refute Sraffa.

Only versions that dispense with the natural rate would evade such a criticism.

But even Mises’s version of ABCT in Human Action uses the “originary interest rate,” which is effectively the same thing as the Wicksellian natural rate. Certainly, in Mises’s equilibrium world called the “evenly rotating economy” (ERE) this would be the same as the Wicksellian natural rate of interest. Mises asserts that there is “a tendency toward the equalization of this ratio for all commodities,” but this is unconvincing, and just as worthless as any other alleged tendency of the real world to a general equilibrium state. It is hard to see how Mises’s version of ABCT is any better than the other versions that use the Wicksellian natural rate of interest.

Rallo speaks of “maturity mismatches” between savers and borrowers being a sufficient condition for an ABC. But this merely begs the question by assuming time preference and loanable funds.

(2) Juan Ramón Rallo argues that the ABCT need not assume the existence of the full employment of resources. Instead, malinvestment might generate localised bottlenecks and differences in the time preferences of savers and capitalists. But, yet again, as in (1), all this just begs the question by assuming the truth of time preference and loanable funds theory, when these very theories are unsound. See also point (4) below.

(3) The difficulties of classifying capital goods into universal, well defined orders is not irrelevant, despite what the author says. In fact, if these well structured orders are flimsy or non-existent, then whole notion of the capital structure lengthening in response to overexpansion of credit is also highly questionable.

Furthermore, Rallo’s assertion that capital is not plastic or homogenous is a straw man argument. I never asserted this.

These articles by Robert Vienneau provide further discussion of this:

Vienneau, R. L. 2006. “Some Fallacies of Austrian Economics,” September
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=921183

Vienneau, R. L. 2010. “Some Capital-Theoretic Fallacies in Garrison’s Exposition of Austrian Business Cycle Theory,” September 4
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1671886

(4) I have difficulty understanding criticism (4) at all. Rallo asserts that interest rates do not seek to coordinate new savings decisions with new investment, which appears to be a strange denial of the loanable funds theory that is certainly used in the ABCT.

(5) Rallo says it not necessary to assume any tendency toward equilibrium or the equalization of profit. He then cites Lachmann in support of this and Lachmann’s version of the ABCT.

But Lachmann denied that universality of the ABCT:

“The Trade Cycle cannot be appropriately described by means of one theoretical model. We need a number of models each showing what happens when certain potential causes become operative. The many models that have been constructed by economists in the past are therefore not necessarily incompatible with each other. Overinvestment and underconsumption theories, for instance, are not mutually exclusive. None of them of course is the true theory of the Trade Cycle; each is probably an unduly broad generalization of certain historical facts. Once we admit the dissimilarity of different historical fluctuations we can no longer look for an identical explanation. In dealing with industrial and financial fluctuations eclecticism is the proper attitude to take. There is little reason to believe that the causes of the crisis of 1929 were the same as those of the crisis of 1873.” (Lachmann 1978:100–101).

So is Rallo willing to say, with Lachmann, that the ABCT is not a universal theory, but compatible with other theories (for example, debt deflation theory or a demand side explanation)?

Moreover, I still doubt that Lachmann’s version of the ABCT is better than any other: if anything, Lachmann’s radical subjectivism and rejection of any strong real world tendency to equilibrium makes it even more likely that the ABCT is false.

(6) In his last point, Rallo seems to concede the existence of administered prices. Yet, for some unexplained reason, he still thinks the “false profits” version of ABCT will work. Again, his argument depends on an economy experiencing real shortage of resources and capital. This ignores the empirical reality that, even in most real world booms, capitalist economies still have significant idle resources and are open to international trade.

Finally, Rallo also tries to conflate asset price bubbles with the capital goods distortion postulated by the ABCT. Yet the classic versions of the ABCT do not postulate asset bubbles as the source of discoordination.

BIBLIOGRAPHY
Garrison, R. W. 2000. Time and Money: The Macroeconomics of Capital Structure., Routledge, London and New York.

Hayek, F. A. von, 1931. Prices and Production. G. Routledge & Sons, Ltd, London.

Hayek, F. A. von, 1935. Prices and Production (2nd edn). Routledge and Kegan Paul.

Lachmann, L. M. 1978. Capital and its Structure. S. Andrews and McMeel, Kansas City.

Mises, L. von. 1934. The Theory of Money and Credit (trans. H. E. Batson from 2nd German edition of 1924), J. Cape, London.

Mises, L. von. 2006 [1978]. The Causes of the Economic Crisis and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala.

Rothbard, M. N. 2004 [1962]. Man, Economy, and State: A Treatise on Economic Principles. Ludwig von Mises Institute, Auburn, Ala.

Rothbard, M. 2009 [1969]. Economic Depressions: Their Cause and Cure. Ludwig von Mises Institute, Auburn, Ala.