Friday, September 19, 2014

Keynes on Economic Calculation

At the conclusion of Chapter 19 of The General Theory, Keynes pointed out that rapid and significant wage and price flexibility, and especially downwards nominal wage movements and price deflation, can wreak havoc in a market economy where many contracts are fixed in nominal terms and subjective expectations play a major role:
“It follows, therefore, that if labour were to respond to conditions of gradually diminishing employment by offering its services at a gradually diminishing money-wage, this would not, as a rule, have the effect of reducing real wages and might even have the effect of increasing them, through its adverse influence on the volume of output. The chief result of this policy would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live. To suppose that a flexible wage policy is a right and proper adjunct of a system which on the whole is one of laissez-faire, is the opposite of the truth. It is only in a highly authoritarian society, where sudden, substantial, all-round changes could be decreed that a flexible wage policy could function with success.” (Keynes 1964 [1936]: 269).
In other words, a system in which rapid and unexpected deflation occurs will cause serious problems in a market economy and to the plans and calculations of business people.

In fact, one of the main purposes of Keynes’ A Tract on Monetary Reform (1923) was to advocate polices to ensure a relatively stable purchasing power for money, given the violent hyperinflations of post-World War I Europe and the destabilising deflation in the UK induced by the return to the gold standard. (At this time of course, Keynes was a quantity theorist, so his polices were then based on the quantity theory of money.)

These points about Keynes are of interest, because the internet is filled with vulgar Austrians and libertarians who seem to think that only the Austrian school has ever understood the truths that
(1) money prices are necessary to calculate profit and loss, and
(2) that business requires a relatively stable purchasing power for money to make these calculations meaningful,
when of course mainstream neoclassical economists and heterodox economists understand this perfectly well (e.g., see Ingham 2011: 45).

Of course, as Keynes thought, steady and low inflation is compatible with effective business calculation, and better than deflation for many reasons, especially if the business community, as they do now, expect a low inflation environment as the normal state of affairs.

Even Mises’ condition for the attainment of effective economic calculation is only a relatively stable purchasing power for money, though he expressed this in the general terms of the quantity theory,* as the need to prevent great changes in the money stock:
“For the sake of economic calculation all that is needed is to avoid great and abrupt fluctuations in the supply of money. Gold and, up to the middle of the nineteenth century, silver served very well all the purposes of economic calculation. Changes in the relation between the supply of and the demand for the precious metals and the resulting alterations in purchasing power went on so slowly that the entrepreneur’s economic calculation could disregard them without going too far afield. Precision is unattainable in economic calculation quite apart from the shortcomings emanating from not paying due consideration to monetary changes. The planning businessman cannot help employing data concerning the unknown future; he deals with future prices and future costs of production. Accounting and bookkeeping in their endeavors to establish the result of past action are in the same position as far as they rely upon the estimation of fixed equipment, inventories, and receivables. In spite of all these uncertainties economic calculation can achieve its tasks. For these uncertainties do not stem from deficiencies of the system of calculation. They are inherent in the essence of acting that always deals with the uncertain future.” (Mises 1998: 225).
Mises was right on this one point, and Keynes would have agreed. But naturally Keynes and Mises would have disagreed on how best to achieve this aim, and on many other points of economic theory. I have shown here how Mises’ other comments about economic calculation can be subject to a Post Keynesian critique, particularly his unrealistic model, on the basis of flexible wages and prices, of how a modern market economy achieves economic coordination.

But, in conclusion, it is true that violent, rapid and unexpected changes in money’s purchasing power – whether it is high inflation, hyperinflation or severe deflation – are to be avoided, so that monetary calculations of businesses about investment, costs of production and profit and loss can be meaningful: pretty much every economist understands this, and the vulgar internet Austrians have no idea what they are talking about.

Note
* I am well aware that Mises and the Austrians do not wholly subscribe to the quantity theory, but have their own criticisms of it, because of the issue of Cantillon effects and how they make the quantity theory’s assumption of a proportional relationship between money supply and price level problematic. So please don’t bother pointing this out to me!

BIBLIOGRAPHY
Ingham, Geoffrey. 2011. Capitalism. Polity, Cambridge.

Keynes, John Maynard. 1923. A Tract on Monetary Reform. Macmillan, London.

Keynes, J. M. 1964 [1936]. The General Theory of Employment, Interest, and Money. Harvest/HBJ Book, New York and London.

Mises, L. 1998. Human Action: A Treatise on Economics. The Scholar’s Edition. Ludwig von Mises Institute, Auburn, Ala.

18 comments:

  1. "rapid and unexpected deflation ... cause[s] serious problems in a market economy and to the plans and calculations of business people." Sounds just like Friedman.
    I eagerly await Bob Roddis's rebuttal.

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    Replies
    1. "no non-Austrian in human history has ever understood economic calculation!" -- or some such idiocy.

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    2. That they do not understand economic calculation is demonstrated by the fact that they do not understand economic MISCALCULATION caused by Keynesian-style policies and/or artificial credit expansion. False prices and all that (to coin a phrase). The Keynesian analysis ignores and suppresses how the problems it seeks to cure actually came about.

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    3. No, roddis, Post Keynesians understand the issues: they just don't agree the Austrian theory works, and have counterarguments that refute you.

      Of course, you are too stupid and too ignorant to engage with these arguments.

      And, in point of fact, you are confusing the issue of economic calculation with the issue of economic coordination.

      Misesian economic calculation means:

      (1) an economy has money prices for capital goods and consumer goods, and

      (2) businesses calculate profits and losses with money prices and the economy has a relatively stable purchasing power for money: as Mises says, "For the sake of economic calculation ALL that is needed is to avoid great and abrupt fluctuations in the supply of money."
      -----------------
      Modern Keynesian economies have economic calculation.

      By contrast, you are complaining that endogenous money, or deficit spending, or central banks distort the (imaginary) Wicksellian unique natural rate of interest, *distort* wages and prices and cause *alleged* inter-temporal miscoordination via Austrian business cycles.

      No, they don't, because

      (1) the Wicksellian unique natural rate of interest cannot even be defined outside a 1 commodity world

      (2) Wicksellian loanable funds is rubbish

      (3) investment isn't a simple function of interest rates

      (4) most prices are relatively inflexible with respect to demand changes anyway

      (5) the whole notion that flexible wages and prices would lead to a tendency to Mises' final state of rest and hence economy-wide economic coordination -- with a tendency to clearing of the labour markets and product markets -- is false.

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    4. Oh, and you're still so ignorant that you cannot give a simple yes/no answer to this question:

      “Is the idea of a tendency towards market clearing wages and prices by human action (even if the whole economy never reaches Mises’s final state of rest equilibrium) a fundamentally important part of the Austrian theory of economic coordination?”

      Yes or no?

      Care to answer?

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  2. I think we have a stand-off here. You go the public with your version and I'll go with mine.

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    Replies
    1. Are you capable of giving a yes/no answer to this question:

      “Is the idea of a tendency towards market clearing wages and prices by human action (even if the whole economy never reaches Mises’s final state of rest equilibrium) a fundamentally important part of the Austrian theory of economic coordination?”
      ----------------
      Or are you just what you appear to be: an ignorant loud-mouth, who does not understand basic Austrian theories and concepts?

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    2. Clearly you are not capable of answering it.

      Conclusion: Roddis does not understand basic Austrian theories and concepts.

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    3. No. The idea is derivative. Undistorted prices will tend to promote more successful plans, both long term and short term. When mistakes are made, they will have to be resolved quickly because there will be no artificial subsidy or bailout for the entrepreneur or consumer who has made errors. Fewer mistakes will be made than under a regime of artificial credit expansion which induces artificial, misleading and unsustainable prices.

      I’ve answered this question so many times before. There is nothing in praxeology that says that humans must value monetary gratification over other types of gratification. See Rothbard on extreme a priori-ism.

      Further, Wicksell and the Austrians have quite a different view of the nature of interest and the nature and source of prices themselves. See KNUT WICKSELL AND LUDWIG VON MISES ON MONEY, INTEREST AND PRICE DYNAMICS BY AGNÈS FESTRÉ*

      http://halshs.archives-ouvertes.fr/docs/00/27/23/99/PDF/Festre_WicksellMises_revised_version_def3.pdf

      Finally, the insights provided from the socialist calculation debate led to a refinement over the decades of the Austrian explanation view of the market process as a process of discovery. Old quotes from the 20s and 30s are less refined that later explanations. See:

      The Economic Calculation Debate: Lessons for Austrians
      Israel M. Kirzner

      http://mises.org/journals/rae/pdf/rae2_1_1.pdf

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    4. As usual roddis, your answer is just a pathetic evasion.

      Is your answer:

      (1) that it is not a "fundamental" idea, but some derivative idea that does not have to be true of market economies? or

      (2) that is not an important idea in any sense? or

      (3) that it is not a "fundamental" idea, but some *important* derivative idea that must be true for the Austrian theory of economic coordination to work?
      -------------------
      If (1), you're utterly ignorant, and have no idea what your talking about.

      If there is no tendency towards market clearing prices and wages, the Austrian theory of economic coordination collapses.

      Same for (2).

      On (3), you'd still be wrong: because it is a fundamental theory. It is the essence of Austrian price theory and the basis of Austrian theory of economic coordination.

      If (1) or (2), it is quite clear that whenever you speak of "Austrian theory", it is simply some bizarre, incoherent gibberish of your own invention, and has little relation to actual Austrian theory.

      You are clearly an ignoramus, a half-wit and an idiot, and it is no wonder nobody takes you seriously.

      I imagine you are an embarrassment to most actual Austrian economists, who would cringe when they read your harebrained ramblings.

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    5. Finally here is what actual Austrian economists say:

      “An equilibrium price is one in which quantity supplied equals quantity demanded. Graphically, it occurs at the intersection of the supply and demand curves. The market tends toward equilibrium: If the current price is above the equilibrium price, there is an excess supply (‘surplus’) and sellers reduce their asking price. If the current price is below the equilibrium price, there is an excess demand (‘shortage’) and buyers increase their offer price.” (Murphy 2006: 19–20).

      “The concept of a glut for a single good is easy enough to understand: there is more supply on the market than demand at the offered price. A glut can be alleviated by a fall in the price of that good. The producers of the good may take a loss if the market price is below their costs, but the market can always clear at some price.”
      Blumen, Robert. 2014. “Say’s Law and the Permanent Recession,” Mises Daily, February 28,
      http://www.mises.org/daily/6676/Says-Law-and-the-Permanent-Recession

      "The market operates by shifting the height of prices so that again and again demand and supply will tend to coincide. If demand for a good goes up, then its price rises, and this price rise leads to an increase in supply. Entrepreneurs try to produce those goods the sale of which offers them the highest possible gain. They expand production of any particular item up to the point at which it ceases to be profitable.” (Mises 2006 [1931]: 156–157).

      "The market process will tend to establish a price that clears the market: all sellers willing to sell at the market price will be able to do so, and all buyers willing to buy at that price will also be able to do so. …. If these dynamics of supply and demand change, the market process will adjust the price to the new realities.” (Callahan 2004: 76).

      "Mises conceives the market process as coordinative, ‘the essence of coordination of all elements of supply and demand.’ This means that the structure of realized (disequilibrium) prices, which continually emerges in the course of the market process and whose elements are employed for monetary calculation, performs the indispensable function of clearing all markets and, in the process, coordinating the productive employments and combinations of all resources with one another and with the anticipated preferences of consumers.” (Salerno 1993: 124).

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    6. Bob,

      please explain clearly what you mean by 'undistorted prices'.

      Please explain clearly what you mean by 'artificial, misleading and unsustainable prices'.

      Please use precise language.

      Thanks.

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    7. I fear you are asking in vain, Philippe.

      But it would interesting to see how he explains 'undistorted prices" if he doesn't think any flexible price system or tendency to market clearing is important.

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    8. He has to clearly define his terms or it will continue to be impossible to have a meaningful argument with him. You should not argue with him until he has clearly defined his terms.

      Delete
  3. Bob,

    please explain clearly what you mean by the term 'economic calculation', and what you mean by the term 'economic miscalculation'.

    Please use precise language.

    Thanks.

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    Replies
    1. If he explained it, it would be clear to everyone that he has no idea about Austrian concepts!

      Delete
  4. Hayek on 'economic calculation':

    "It seems to me that the decisive factor that would create a general preference for a currency stable in value would be that only in such a currency is a realistic calculation possible, and therefore in the long run a successful choice between alternative currencies for use in production and trade. In particular, the chief task of accounting, to ensure that the stock of capital of the business is not eaten into and only true net gains shown as profits available for disposal by the shareholders, can be realised only if the value of the unit of account is approximately stable.

    An attempt to explain further why successful economic calculation is possible only with a stable value of money raises the question of what precisely we mean by 'the value of money' and the various respects in which it may be kept stable. This we must leave to Section XIII. For the present we content ourselves with the empirical fact that effective capital maintenance and cost control is possible only if accounts are kept in a unit that in some sense remains tolerably stable." (p.69)

    "The reason why people will tend to prefer a currency with a value stable in terms of commodities will thus be that it will help them to minimise the effects of the unavoidable uncertainty about price movements because the effect of errors in opposite directions will tend to cancel each other out. This cancelling will not take place if the median around which the deviation of individual prices clusters is not zero but some unknown magnitude". (p.74)

    Friedrich Hayek, 'The Denationalisation of Money' (1974)

    https://mises.org/books/denationalisation.pdf

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  5. Armen Alchian shows that Keynes did not understand economic calculation:

    http://www.jstor.org/stable/1821390


    ReplyDelete