Showing posts with label reply. Show all posts
Showing posts with label reply. Show all posts

Friday, September 6, 2013

Reply to a “Red Herring on Praxeology”

My recent posts on epistemology and praxeology are criticised here:
“A Red Herring on Praxeology: A Reply to Lord Keynes,” Economic Thought, 6 September, 2013.
Note that the post was written by Mattheus von Guttenberg, not Jonathan Finegold Catalán.

Let us take the major points one by one:
(1) The first point is as follows:
“Lord Keynes tries to undermine Kant’s notion of the synthetic a priori by use of empirical evidence. This will not do. The synthetic a priori, as Kant formulates it, is a category of knowledge by which we come to understand synthetic claims (claims about the real world) by means of aprioristic reasoning (logical deduction). Pointing to an empirical event as falsifying or refuting a claim about a methodology misses the mark entirely. Kant’s ideas on the synthetic a priori may well be wrong or mistaken, but one must prove so by means of showing where the logical error lies. It is simply poor philosophy to argue that an empirical event can refute epistemic claims. This is a category mistake. Epistemic claims — claims of how we understand knowledge — are of an altogether different category than claims of knowledge themselves.”
The idea that one cannot refute the claim that some particular knowledge x is synthetic a priori is a bizarre assertion, and entails that modern science did not refute the rationalist claim that Euclidean geometry was a universal theory of space known as necessarily true a priori. Is that what Mattheus von Guttenberg thinks?

Kant’s synthetic a priori knowledge is known with necessary truth, and known without appeal to empirical evidence. Yet, as we will see below, it was precisely the collapse of most imagined synthetic a priori knowledge via the empirical evidence from modern science that credibly refuted the existence of this type of knowledge. Other remaining kinds of synthetic a priori knowledge, such as mathematics, have been shown logically to be analytic a priori statements deduced from axioms, and ultimately non-informative in an empirical sense.

(2) The next claim is this:
“In the second place, Kant’s musings on pre-Einsteinian geometry are fascinating, but hardly foundational for the synthetic a priori paradigm.”
On the contrary! Euclidean geometry was the most fundamental kind of knowledge that Rationalists down through the centuries have relied on to support their claim that there was synthetic a priori knowledge.

Euclidean geometry was the very paradigm of alleged synthetic a priori truth (Salmon 2010: 393; Musgrave 1993: 245–246).

(3) Next, we have this:
“Just because Kant did not, or could not, imagine non-Euclidean geometric theorems does not invalidate his notions on the category of the synthetic a priori in general.”
As it happens, the collapse of Euclidean geometry as a universal theory of space known a priori deprived Kant of his major example of alleged synthetic a priori knowledge, but, fundamentally, all of Kant’s alleged synthetic a priori knowledge has also collapsed in the light of modern science and philosophy of mathematics, whether it is Euclidean geometry, time, deterministic causality, mathematics, and so on.

For example, the very belief that we can know a priori that time passes objectively and unidirectionally towards the future is disputed by many physicists on the basis of general relativity, and it is the Eternalist/Block Universe theory of time that is adopted by numerous physicists today. This Eternalist theory actually entails that the perception of the passing of time is an illusion. Although there is a rival theory called Presentism, we cannot know which theory is correct a priori, and the question will be determined empirically.

Moreover, quantum mechanics destroyed the idea of universal deterministic causality known a priori.

Even logical truths like the Law of Excluded Middle, when regarded as universally true a priori, is possibly refuted by quantum mechanics, as Willard Van Orman Quine noted long ago, though he was even more radical in that he denied any strict distinction between even analytic and synthetic truth:
“Furthermore it becomes folly to seek a boundary between synthetic statements, which hold contingently on experience, and analytic statements which hold come what may. Any statement can be held true come what may, if we make drastic enough adjustments elsewhere in ... [sc. our web of belief]. Even a statement very close to the periphery can be held true in the face of recalcitrant experience by pleading hallucination or by amending certain statements of the kind called logical laws. Conversely, by the same token, no statement is immune to revision. Revision even of the logical law of the excluded middle has been proposed as a means of simplifying quantum mechanics; and what difference is there in principle between such a shift and the shift whereby Kepler superseded Ptolemy, or Einstein Newton, or Darwin Aristotle?” (Quine 1951: 40).
(4) Then this passage from Hoppe is quoted:
“Since the discovery of non-Euclidean geometries and in particular since Einstein’s relativistic theory of gravitation, the prevailing position regarding geometry is once again empiricist and formalist. It conceives of geometry as either being part of empirical, aposteriori physics, or as being empirically meaningless formalisms. Yet that geometry is either mere play, or forever subject to empirical testing seems to be irreconcilable with the fact that Euclidean geometry is the foundation of engineering and construction, and that nobody there ever thinks of such propositions as only hypothetically true.”
The final sentence in this passage is a non sequitur.

Yes, Euclidean geometry is a highly useful system in a limited domain. But how can we justify that it is useful in this limited domain? The answer is: empirically.

We have a great deal of empirical evidence over a long time that Euclidean geometry is useful in a certain domain. Yet its truth as a physical theory of space in that domain is only ever extremely probable and known a posteriori.

Contrary to Hoppe, that fact that “nobody [sc. in engineering and construction] … ever thinks of such propositions as only hypothetically true” is irrelevant! Hoppe has committed a crude informal logical fallacy called the appeal to (invalid) authority (and it may also imply an equally fallacious argumentum ad populum). People who work in engineering and construction most probably do not understand the evidence and arguments from modern science and philosophy of science, so their opinion on this question cannot prove Hoppe’s point, because they are invalid authority. (And even our belief in the probable truth of modern scientific theories ultimately does not come from any consensus of scientists, but from the strength of the arguments and evidence for, and the empirical testing and predictive power of, scientific theories.)

In modern philosophy of science, all scientific theories and geometries (asserted as true theories of real space) are only ever highly probable, fallible, but not certain. Even the scientific theory that the earth revolves around the sun is ultimately an extremely probable theory that has been confirmed by a vast amount of evidence, but could in theory be false.

For example, can we know a priori that Euclidean geometry is a necessarily true theory of all space in our universe? That is what the advocate of classical synthetic a priori knowledge is claiming, and yet the belief that Euclidean geometry was a universally true theory known a priori is precisely what was discredited when general relativity and non-Euclidean geometry received overwhelming empirical support.

(5) Furthermore, as a matter of fact, von Guttenberg’s claim that I only think that there are two forms of knowledge – analytic a priori or synthetic a posteriori – is false, since I happen to think that Kripke’s necessary a posteriori knowledge is a defensible third type (though I find Kripke’s concept of the contingent a priori unconvincing). But Kripkean necessary a posteriori propositions are epistemologically different from synthetic a priori ones, and seem of little value to modern Rationalists, since they apply to identity statements using proper names, definite descriptions, or scientific statements of the essence of natural kind terms, and are also only known by empirical evidence (that is, a posteriori).

(6) Finally, von Guttenberg offers these remarks on causality:
“Even making empirical observations requires that the observer understand a causal framework, simply in order to make sense of his observations. The understanding of causality is thus inherent and irrefutable within every action. This renders causality to the status of the synthetic a priori and—that every event is interconnected with other events and causes—is both true logically, because every action demonstrates the actor must know this, and it also gives us usable and important information about the real world.”
No, making empirical observations presupposes some metaphysical assumptions, such as the validity of induction, the universality of the laws of nature in space and time, the existence of an external world, and so on.

But these are not known a priori: they are defended with probable inductive arguments (some better than others), and the justification of these metaphysical assumptions is not certain: modern science has long since abandoned apodictic certainty, or any belief that mere human intuition gives necessary truth.

Take causality: the Kantian idea of necessary, deterministic causation as a universal truth known a priori is untrue given the idea of probable but not necessary causation in modern quantum physics (Melnick 2006: 229; Anscombe 1993), which now also separates the notions of causation and determinism (Weinert 2004: 260).

An even more shocking possibility can be given. Kant apparently thought that the principle of the uniformity of nature was a synthetic a priori statement. But a few years ago some remarkable evidence was reported that the “fine structure constant” (or what is called “alpha”) – a fundamental law of nature – may not be constant throughout the universe:
“Laws of Physics Vary Throughout the Universe, New Study Suggests,” Sciencedaily.com, 9 September, 2010.

Michael Brooks, “Laws of Physics may change across the Universe,” New Scientist, 8 September 2010.
If even fundamental laws of nature as established by modern science can be empirically falsifiable, there is little hope for the rest of Kant’s synthetic a priori knowledge.

BIBLIOGRAPHY
Anscombe, G. E. M. 1993. “Causality and Determination,” in Ernest Sosa and Michael Tooley (eds.), Causation. Oxford University Press, Oxford.

Melnick, Arthur. 2006. “Kant’s Proof of Substance and Causation,” in Paul Guyer (ed.), The Cambridge Companion to Kant and Modern Philosophy. Cambridge University Press, Cambridge. 203–237.

Musgrave, Alan. 1993. Common Sense, Science and Scepticism: Historical Introduction to the Theory of Knowledge. Cambridge University Press, Cambridge.

Quine, W. V. 1951. “Two Dogmas of Empiricism,” Philosophical Review 60: 20–43.

Salmon, W. C. 2010. “Geometry,” in Jonathan Dancy, Ernest Sosa, and Matthias Steup (eds.), A Companion to Epistemology (2nd edn.). Wiley-Blackwell, Chichester, UK and Malden, MA. 393–395.

Weinert, Friedel. 2004. The Scientist as Philosopher: Philosophical Consequences of Great Scientific Discoveries. Springer, Berlin and London.

Tuesday, August 6, 2013

Reply to Juan Ramón Rallo, Part 5

Juan Ramón Rallo’s new response:
“Siguiendo con las réplicas a Lord Keynes: reconversiones de capital y comercio exterior (parte 5),” 5 August, 2013.
Rallo contends that his point, from the beginning of this debate, was that the “Wicksellian natural rate of interest is anti-Austrian, unnecessary and misleading” (“el tipo de interés natural wickselliano es anti-austriaco, innecesario y falaz”).

Furthermore,
“1.3. As I also said from the beginning, the traditional versions of the Austrian theory fail by seeking to incorporate the Wicksellian natural rate. But they are easily amended by replacing that concept with a much more realistic maturity mismatch [sc. process] and the consequent flattening of the yield curve.

“1.3. Como también dije desde el comienzo, las versiones tradicionales de la teoría austriaca fallan al pretender incorporar el tipo natural wickselliano. Pero son fácilmente enmendables sustituyendo ese proceso por el mucho más realista descalce de plazos y el consecuente aplanamiento de la curva de rendimientos.”
The first sentence is exactly what I have been saying all along: all versions of the ABCT that are based on the unique Wicksellian natural rate are flawed and unsound.

Is one wants to reformulate ABCT with the mechanism of “maturity mismatch” and the “flattening of the yield curve,” where are the Austrian books or published papers that have done this?

Point (3.1) argues that American savings during WWII allowed it an easy post-war conversion:
“[sc. for] a society that massively increases its savings, it is very easy to revive growth in the short term and in the medium term to reconvert its production structure (hence Austrians insist so much on the need to save).”

“una sociedad que incremente su ahorro masivamente, lo tiene muy fácil para reactivar a corto plazo su crecimiento y reconvertir a medio plazo su estructura productiva (por eso los austriacos insistimos tanto en la necesidad de ahorrar).”
But, despite Rallo’s denial to the contrary (“Nótese, además, que no me estoy refiriendo a ahorro monetario, sino a ahorro real”), the saving in WWII was monetary: in the form of increased bank balances and financial assets.

Real “savings” – the resources not consumed – were being used up in war production. When the war ended, there was personal and corporate monetary dissaving, and an investment boom.

I cannot see how my point about how the adjustment was remarkably smooth has been refuted.

On (3.2), I have already admitted that US real GDP fell in the years after 1945: but that was the decline caused by the end of war production. At the same time, a private investment boom occurred and unemployment did not rise catastrophically.

The Austrian theory says that as unsustainable capital projects fail and are liquidated, unemployment should rise and a protracted bust should occur. That is exactly what did not happen from 1946–1948.

Monday, August 5, 2013

Reply to Juan Ramón Rallo, Part 4

The indefatigable Juan Ramón Rallo posts a further reply to me:
“Otra réplica a Lord Keynes: atesoramiento, capital y recursos ociosos (parte 4),” 4 August, 2013.
Some comments:
(1) Rallo now says that the Wicksellian natural rate is “a concept ... foreign to the Austrian tradition and it is unnecessary for the theory of the cycle” (“como digo, semejante concepto es ajeno a la tradición austriaca y es innecesario para la teoría del ciclo”).

Now we are back in circles, for this implies that I am right that all versions of ABCT that are based on the natural rate cannot be theoretically sound. And that is very large number, including the work of Mises, Hayek, Rothbard, and Garrison.

(2) Rallo seems to admit that money hoarding and lack of spending on newly produced goods and services does cause macroeconomic problems (“mi punto no es que un atesoramiento excesivo no pueda causar problemas macroeconómicos”).

I baffled by the comment that “savers may wish … production structures much safer (less risky) than today because risk aversion has increased” (“Los ahorradores pueden desear, por ejemplo, estructuras productivas mucho más seguros (menos arriesgadas) que las actuales por cuanto su aversión al riesgo se haya disparado”). Any saver increasing his holding of money or liquid financial assets today does not generally want the aggregate level of production or employment to fall. The loss of employment and output from increased aggregate saving is a largely unintended macroeconomic consequence of individual micro decisions. The vast majority of such people do not want to see mass unemployment that would make it likely that they, too, will their job and income.

(3) Regarding WWII in the US, there was a great deal of monetary saving, but massive use of real resources. The “real” saving that was done allowed diversion of resources to war production and the creation of a vast new number of capital projects related to the war production.

I fail to see how my comments about the rapid and successful conversion of war economy have been refuted. The immediate years after the war when this boom happened occurred at a time when prices and wages were the most inflexible they had ever been in US history. Numerous government interventions still existed. Yet some massive painful restructuring of the US capital structure analogous to the bust of ABCT with rising unemployment did not happen.

(4) Regarding the financial system and Minsky’s theories, Post Keynesianism says that the financial sector must be effectively regulated to prevent speculative and Ponzi financing of asset bubbles.

Regarding (4.4), I do not say that the developing world must be willing to finance all production equipment and investment around the world (!) (“¿Están dispuestos los países en desarrollo a financiar la reconversión de todos los aparatos productivos de todo el planeta?”).

What I said is this: any one country (for example, Canada) could meet capital shortages during booms by trading with its trading partners, whether in the developed world or developing world (for example, Canada can trade with the US, Europe, Australia, China or many other nations), not that a nation must meet all of its capital requirements from the developing world.

Furthermore, Rallo’s “real” analysis of international trade is faulty. All goods imported do not just trade for goods exported (whether imagined as a direct or even an indirect exchange). Imports are paid for with money, usually foreign exchange reserves. A country can obtain foreign exchange either by (1) selling goods through exports, (2) selling assets (real or financial) to foreigners or (3) foreign direct investment.

When a Spanish company buys Chinese capital goods and pays in US dollars, it has discharged its debt to the Chinese supplier. It does not necessarily “owe” real goods to China at all.

Sunday, August 4, 2013

Reply to Juan Ramón Rallo, Part 3

Juan Ramón Rallo provides another reply to me here:
“Nueva réplica a Lord Keynes: preferencia temporal y tipos de interés (parte 3),” 4 August.
At this point, I suspect further argument on each specific point seems unnecessary, as (1) I do not see much that has changed from his previous comments, and (2) no doubt language difficulties obscure proper understanding on both sides.

I would stress that I support Post Keynesianism, and perhaps Juan Ramón Rallo is unfamiliar with Post Keynesian economic theory.

But be that as it may:
(1) Rallo seems to say he concedes nothing about Sraffa (“Temo no haber concedido nada en relación con Sraffa”).

If that is so, it means we are back to square one.

But, for an examination of why Lachmann’s response to Sraffa fails, see (of all people!) the work of the Austrian Robert P. Murphy:
“Robert P. Murphy on the Sraffa-Hayek Debate,” July 19, 2011.
(2) That hoarding of money or spending on liquid financial assets is a way “to hedge against uncertainty” is also a standard Post Keynesian view, so Rallo’s point (1.4) has no force against me.

Rallo says that “from an individual perspective it is clear that hoarding is not only saving money but also investment: investment in liquid assets,” and that, because of the deflationary pressures hoarding causes, it is therefore a “profitable production processes aimed at making money” (“rentabilizar los procesos productivos dirigidos a fabricar dinero: es, por consiguiente, una inversión productiva en dinero”).

That severe macroeconomic problems would not be caused by a (1) sufficient level of hoarding, (2) unwillingness to spend on newly produced goods and services and (3) inducement of deflationary pressures can only be maintained by someone ignorant of the effect that these things would have on business expectations, investment and exacerbation of debt deflationary processes.

(3) Regarding the capital structure of real world capitalism economies, there is a simple empirical example that shows how unrealistic the Austrian view is: the post-WWII growth of the US economy from 1946–1948.

On any Austrian view, there must have been massive malinvestment in the US during the years from 1941 to 1945. When the war ended, many factories and capital goods no doubt were no longer useful, but many others were. Yet other capital was malleable and adaptable.

If the Austrian theory of capital were true, there should have been a devastating US depression after WWII as malinvestments were liquidated and unemployment soared (even if we take account of government programs like the G.I. Bill). But instead the economy adjusted rapidly and boomed: real GDP did indeed fall as war output was ended, but conversion occurred with remarkable speed and success.

(4) Rallo says that he does not think fractional reserve banking is fraud, so that I was wrong in thinking that. Fair enough. I was wrong.

Instead, the “maturity mismatch” is the issue. “Maturity mismatch,” he says, causes intertemporal discoordination: banks provide (1) demand deposits repayable on demand but (2) also fund capital investments with medium to long term loans, which (allegedly) causes a mismatch between real saving and real investment.

First, I am mystified how anyone can say that “[n]one of this has to do with fractional reserve banking” (!) (“Nada de esto tiene que ver con la reserva fraccionaria”). On the contrary, the “maturity mismatch” Rallo speaks of cannot but be the result of fractional reserve banks offering demand deposits and making money by lending with time/term deposits.

Secondly, again we are back to the erroneous time preference theory of interest rates, the requirement that an economy is running at full employment, and the inability to understand that modern capitalist economies require endogenous money systems and the creation of new credit money to achieve strong investment and growth.

Reply to Juan Ramón Rallo, Part 2

Juan Ramón Rallo replies to me here:
Juan Ramón Rallo, “Réplica a Lord Keynes sobre la teoría austriaca del ciclo económico,” 4 August, 2013.
Some responses:
(1) On the non-existence of the unique Wicksellian natural rate of interest, Rallo appears to concede that, once Sraffa’s critique of Hayek (1932a, 1932b) on this issue is accepted, the classic versions of the ABCT are clearly unacceptable. Well, I am not sure how this isn’t a victory for me.

Now Rallo says this does not matter because the ABCT is still being developed, and it is a type of “work-in-progress.” If one wants to believe that, then Austrians should be very humble indeed in their claims about what the theory can explain, because they do not even have a well formulated theory.

The rest of Rallo’s points from (1.2) to (1.7) simply assume the truth of time preference and loanable funds. Yes, if he thinks that these theories are true, he might be able to defend a version of ABCT. I have already made it clear that there are strong reasons for rejecting the truth of time preference interest rate theory and loanable funds.

Rallo says that
“every saver has a projected path of future consumption that, in the aggregate, must match the path of future production planned by producers/investors.”

“Cada ahorrador tiene una senda prevista de consumo futuro que, en agregado, debe coincidir con la senda de producción futura planeada por los productores/inversores.”
No, that is simply untrue.

As Keynes said,
“An act of individual savings means – so to speak – a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption.” (Keynes 1936: 210).
If a person saves $100 today, there is no necessary reason why $100 will be spent on goods or services at any time in the future.

Or, to say it in Spanish: Si una persona ahorra $ 100 hoy en día, no hay ninguna razón necesaria por 100 dólares se gastarán en cualquier momento en el future (though no doubt this is terrible Spanish, as I have used a machine to translate it).

There is no necessary reason why an act of saving of money today must entail a future act of consumption (Hill 1996: 40). Just because interest rates fell when $10,000 was saved and put in banks, it does not follow that this indicates that the savers now want to buy $10,000 worth of goods at some time in the future. Money invested can simply be invested again in the future. Or money spending can be on (1) newly produced goods and services, (2) second hand goods and services or (2) assets on secondary markets. There is no reason why it must always be on newly produced goods and services.

In short,
(1) a decision to save money now does not entail a future consumption purchase;

(2) saved money now need not be invested in capital goods projects, and may be used to buy secondary assets (either real or financial). A large stock of money is at any one time tied up in purchases and sales of secondary assets;

(3) money made available for capital goods investments may have simply been shifted from purchasing of secondary assets (either real or financial) and not from abstention from consumption, and there need be no change in time preference, only liquidity preference.

(4) changes in monetary interest rates, even in hypothetical free market economies, need signal no reliable information and indeed no information at all about time preference or real resource availability.
With his emphasis on “maturity mismatch,” Rallo seems to be thinking in the crudest Rothbardian terms in which fractional reserve banking is illegitimate and all loans must be “term deposits” or “time deposits” (or a “depósito a plazo fijo,” which I think is what the Spanish call this). In reality fractional reserve banking is not fraud or illegitimate, demand deposits and loans callable on demand are perfectly legitimate.

Or perhaps Rallo is a student of Jesús Huerta de Soto (a Spanish Austrian economist at the Universidad Rey Juan Carlos), who makes the same errors.

I have already demonstrated the severe flaws in Jesús Huerta de Soto’s view of banking here:
“Why is the Fractional Reserve Account a Mutuum, not a Bailment?,” December 17, 2011.

“Callable Option Loans and Fractional Reserve Accounts,” December 16, 2011.

“Future Goods and Fractional Reserve Banking,” December 15, 2011.

“Lawrence H. White refutes Huerta de Soto on Fractional Reserve Banking,” February 22, 2011.

“The Mutuum Contract in Anglo-American Law,” September 30, 2011.

“Huerta de Soto on the Mutuum Contract: A Critique,” August 11, 2012.

“A Simple Question for Opponents of Fractional Reserve Banking,” August 17, 2012.

“Chapter 1 of Huerta de Soto’s Money, Bank Credit and Economic Cycles: A Critique,” August 31, 2012.

“Huerta de Soto on Justinian’s Digest 16.3.25.1,” September 1, 2012.

“Huerta de Soto on Banking in Ancient Rome: A Critique,” September 2, 2012.
(2) The discussion of idle resources merely continues to assume the truth of the flawed theories ABCT requires to work: the coordinating role of interest rates that communicate information about time preference and that investment in real world economies can become so intense that severe physical shortages of capital occur to cause widespread collapse of investment projects.

The reality is that, even in strong booms, businesses still carry stocks or inventories of goods, resources are not fully used, international trade makes goods available from overseas and even workers can be hired from overseas.

(3) Again, most of the criticisms against me reduce to saying I think capital is homogenous putty, but I have said no such thing.

(4) I have already dealt with the reasons why time preference theory of interest rates and loanable funds are unacceptable in (1) above.

(5) This seems to be an admission that Lachmann did not think that the ABCT was a universal theory, but nevertheless ABCT is valid because it explains intertemporal discoordination. See (1) above.

(6) The whole idea of “artificial credit expansion” begs so many questions: it assumes the truth of Rothbard’s anti-fractional reserve banking ideology and the truth of strict loanable funds.

It also bespeaks an inability to see that money is endogenous in modern credit and banking systems.

BIBLIOGRAPHY

Hill, Greg. 1996. “The Moral Economy: Keynes’s Critique of Capitalist Justice,” Critical Review 10: 411–434.

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

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.

Saturday, August 3, 2013

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.

Wednesday, January 30, 2013

The Natural Rate of Interest and the Austrian Business Cycle Theory: A Reply

One Guillermo Sanchez has a post here defending the Austrian business cycle theory (ABCT):
“Sraffallacies: A Misesian Defense of ABCT (II),” Econo-Mia [y Tuya], January 29, 2013.
If I am not mistaken, Guillermo Sanchez already acknowledges that Sraffa’s critique of Hayek on the non-existence of the Wicksellian natural rate of interest is sound.

Sanchez states:
“Robert P. Murphy’s great paper “Multiple Interest Rates and Austrian Business Cycle Theory” (2010) takes the subject directly as Lachmann did. The enormous merit of this paper is that even if Sraffa was right, his critique does not refute ABCT. In other words he was able (after criticizes Lachmann’s solution) to ensure the validity of ABCT in Sraffa’s own terms (a multiple rates environment). ABCT is still valid even in the circumstances in which Sraffa said it would not be valid. He managed to do it using a Dynamic Equilibrium simple model. Maybe the best refutation is not to demonstrate that Sraffa was wrong, but to demonstrate that even if he was right, the theory still holds logically”
What Sanchez is trying to argue here is that ABCT can be reformulated by purging it of its use of the natural rate of interest, and that such a reformulated ABCT can be defended against Sraffa’s critique on the basis of the mythical natural rate.

That is perfectly true, of course, and I have never denied this. The problem is that such a theory is not a Hayekian theory, it requires real world tendency to a general equilibrium state, and it is still subject to a host of other problems, such as subjective expectations, uncertainty, capital theory, unrealistic assumptions about use of resources, and so on.

But let me turn to the specific criticisms Sanchez has of my arguments:
(1) First, Sanchez points out a red herring:
“Lord Keynes” does not mention the fact that Mises was not the only one whose theory relied on the [W]icksellian natural interest rate concept. Keynes himself confessed that he also relied on it on the same time (early 30s) that Sraffa accused Hayek of using that unique rate concept …. As everybody knows, in the early 30s (and before that) Keynes was a [W]icksellian and a quantitative [= “quantity” – LK] theorist.
Yes, before the General Theory Keynes was indeed a quantity theorist and used the natural rate. But so what? Keynes was wrong.

Let me repeat that: Keynes was as wrong and misguided as any neoclassical in these years in his use of these concepts.

But, in the end, Keynes abandoned the natural rate idea between the Treatise on Money and his writing of the General Theory. Keynes came to see that the “natural rate” does not equate investment with savings, that savings can be much higher than investment, and that subjective expectations can shatter business confidence.

(2) Next, Sanchez asks me this:
“Why did ‘Lord Keynes’ accuse Mises (or Hayek) of using Wicksell’s natural rate and did not say anything about Keynes who was using it too two years after Mises and at the same time that Sraffa was accusing Hayek of using that [W]icksellian concept? Has he the guts to refute his ‘master’’s Treatise and his previous books because he was using the [W]icksellian natural rate concept? Can LK write ‘Keynes’s early theory is a complete nonsense because he relied on [W]icksellian theory of natural rate of interest’ or ‘All Keynes’s pre-GT writings on monetary and interest theory are worthless because he relied on [W]icksellian natural rate’? I doubt it. But let’s assume LK admits it and says “yes, all what Keynes wrote before GT is garbage because he relied on Wicksell natural rate. But obviously later on he did not used that faulty concept.”, however he himself has confessed that Mises in his later treatments abandoned that concept too. So in order to be intellectually honest he must say that Mises-ABCT is as immune to Sraffa’s criticism as it is the monetary and interest theory of Keynes in GT.”
The answer is “yes.” A great deal of what Keynes wrote before the General Theory is wrong, because of his use of neoclassical theory. (Although not all of it is wrong, for Keynes was, for example, receptive to the Chartalist theory of money and wrote some quite insightful though things about the history and nature of money).

In fact, I am surprised that any knowledgeable Austrian really thinks he has scored any points here. And, as I have admitted above, yes, a version of the ABCT purged of the Wicksellian natural rate of interest can be defended against Sraffa.

(3) The third issue is that Mises’s originary interest rate is still a flawed, real theory of interest. Interest is a monetary phenomenon, not explained by time preference.

If Mises’s originary interest rate is false, it follows that his later version of the ABCT (without the natural rate) still has a severe flaw.

(4) The objection that an economy where factor inputs are relatively abundant still poses a serious problem to the Austrian business cycle theory, despite what Sanchez says.

Instead of dealing with this issue, he merely distorts the issue, by attributing a straw man to his opponents. Keynesians and even Marxists do not deny that insufficient resources are often a problem in the real world.

The word “scarce” can have two meanings: (1) finite, and (2) insufficient quantities available in relation to demand. When I say that something is “relatively abundant,” I mean that it is available in a quantity that exceeds the demand for it.

But relative scarcity and relative abundance in these senses exist, and an economy can have a relative abundance of certain goods in any time outside a boom. International trade also provides goods even when domestically there might be shortages.

Nor do I deny that as an economy expands and reaches a boom, inflationary pressures build up as resources become less available.
Critics of my posts on the ABCT have simply misunderstood my critique. The non-existence of the natural rate of interest is one of the reasons why Hayek’s early business cycle theory is wrong. That critique applies to all Hayekian forms of the theory that use the natural rate, and even these Austrian critics are admitting this point.

The other versions of ABCT are flawed for other reasons. One of these is the unrealistic assumption of a economy that converges to a general equilibrium state:
“Hayek’s Trade Cycle Theory, Equilibrium, Knowledge and Expectations,” January 4, 2012
An unrealistic capital theory is yet another problem, as I have shown here:
“Hayek on his Simplified Capital Theory Assumptions in Prices and Production,” October 15, 2012.

“Why Isn’t the Boom of 1946-1948 a Problem for Austrians?,” June 2, 2012.

Thursday, September 6, 2012

Reply to “Unemployment, Deflation and Growth During the Period of 1873–1896”

A commentator on Mises.org called “Rodolphe Topffer” attempts a critique of my views on US GNP growth in the late 19th century:
“Unemployment, Deflation and Growth During the Period of 1873–1896,” 4 September, 2012.
My response:

(1) The whole post suffers from the use of a straw man argument.

Curiously, the author cites Bordo and Filardo for the view that it is “abundantly clear that deflation need not be associated with recessions, depressions, and other unpleasant conditions” – but this very view is, as far as I can see, already accepted by Keynesians. Certainly, I accept it.

The idea that there is “a common belief among Keynesians that a situation of a falling prices will result in a recession” is simply not true, if by that we mean that academic Keynesian economists think that price deflation always results in recession. On the contrary, any Keynesian with a decent knowledge of economic history knows about the long period of deflation in the Western world from 1873–1896, during which there was in fact real output growth. In one of the first posts on my blog, I in fact noted this myself.

Now what Keynesians would say is that deflation can be a consequence of economic crisis when the money supply collapses, or that, in an environment of heavy private debt, steep deflation is likely to induce debt deflationary effects. This is quite different from thinking price deflation is always bad or results in real output collapse.

(2) Rodolphe Topffer states:
“The periods running from 1873 to 1879 and 1879 to 1896 show a huge increase in GNP per capita, see Rothbard (2002) ‘A History of Money and Banking in the United States’ (see pages 360–361, 400–403, 154–155, 159–161, 164).”
Let us look at US per capita GDP in the late 19th century from the figures in Angus Maddison (2006), which appear to be calculated from the estimates in Balke and Gordon (1989):
US per capita GDP 1870–1900
(in 1990 international Geary-Khamis dollars)

Year | GDP | Growth rate
1870 | 2445 |
1871 | 2489 | 1.79%
1872 | 2524 | 1.40%
1873 | 2562 | 1.50%
1874 | 2601 | 1.50%
1875 | 2643 | 1.61%
1876 | 2686 | 1.62%
1877 | 2732 | 1.71%
1878 | 2780 | 1.75%
1879 | 2829 | 1.76%
1880 | 2880 | 1.80%
1881 | 2921 | 1.42%
1882 | 2963 | 1.43%
1883 | 3008 | 1.51%
1884 | 3056 | 1.59%
1885 | 3106 | 1.63%
1886 | 3158 | 1.67%
1887 | 3213 | 1.74%
1888 | 3270 | 1.77%
1889 | 3330 | 1.83%
1890 | 3392 | 1.86%
1891 | 3467 | 2.21%
1892 | 3728 | 7.52%
1893 | 3478 | -6.70%
1894 | 3314 | -4.71%
1895 | 3644 | 9.95
1896 | 3504 | -3.84%
1897 | 3769 | 7.56
1898 | 3780 | 0.29
1899 | 4051 | 7.16
1900 | 4091 | 0.98
Average Growth Rate 1871–1900: 1.78%
Average Growth Rate 1873–1879: 1.64%
Average Growth Rate 1879 to 1896: 1.36%
Average Growth Rate 1871–1880: 1.64%
Average Growth Rate 1881–1890: 1.65%
Average Growth Rate 1891–1900: 2.04%
(Maddison 2006: 465–466).
The average per capita GDP rate from 1873 to 1879 was 1.64%.

The average per capita GDP rate from 1879 to 1896 was 1.36%. This was not especially high historically.

As always, the data is only an estimate and might be challenged. For example, Joseph H. Davis’s (2006) list of recessions in the 19th century, on the basis of his annual dataset of US industrial production from 1796 to 1915, shows that the US had a recession from 1873 to 1875 lasting about 3 years, a recession which is absent from Balke and Gordon (1989).

If Davis is right, the mid-1870s was hardly a prosperous period.

The most telling data is unemployment, which we can see here from the estimates is that of J. R. Vernon (1994):
Year | Unemployment Rate
1869 | 3.97%
1870 | 3.52%
1871 | 3.66%
1872 | 4.00%
1873 | 3.99%
1874 | 5.53%
1875 | 5.83%
1876 | 7.00%
1877 | 7.77%
1878 | 8.25%
1879 | 6.59%

1880 | 4.48%
1881 | 4.12%
1882 | 3.29%
1883 | 3.48%
1884 | 4.01%
1885 | 4.62%
1886 | 4.72%
1887 | 4.30%
1888 | 5.08%
1889 | 4.27%
1890 | 3.97%
1891 | 4.34%
1892 | 4.33%
1893 | 5.51%
1894 | 7.73%
1895 | 6.46%
1896 | 8.19%
1897 | 7.54%
1898 | 8.01%
1899 | 6.20%

(Vernon 1994: 710).
The 1873–1896 era saw two periods of rising unemployment: (1) 1875–1878 and (2) 1893–1896.

Thus the period from 1873–1896 in the US had two periods of economic crisis: the mid/late 1870s and 1893–1896. During both these periods unemployment rose sharply. A financial crisis also appears to have begun the crisis periods. It is quite likely that the economy in both 1870s and 1890s experienced some degree of debt deflation, so that the deflation was the cause of economic malaise.

(3) The author objects to a comparison of per capita GDP between 1946–1973 and 1873–1896, but the major objection is simply absurd:
“2) Theoretically, we can say that economic growth is much easier when the economy has to recover from the damages caused by the war. The comparison therefore does not hold.”
Why is this absurd? The US was not invaded or damaged during the war in the way the European economics were. Thus there was no “war reconstruction” in the US as there was in Europe. Instead, what occurred was the reconversion of the US economy from its wartime command structure to a peacetime consumer economy. That was certainly accomplished by 1950. So even if we were to subtract the 1946–1949 period, it is obvious that a comparison of 1950–1973 with an equivalent period in the late 19th century (say, 1873–1896) should be perfectly justifiable.



BIBLIOGRAPHY

Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Davis, J. H. 2006. “An Improved Annual Chronology of U.S. Business Cycles since the 1790s,” Journal of Economic History 66.1: 103–121.

Maddison, Angus. 2006. The World Economy: Volume 1: A Millennial Perspective and Volume 2: Historical Statistics. OECD Publishing, Paris.