Sunday, December 23, 2012

Murphy versus Huerta de Soto on the Government’s Ability to Increase Employment and Output

Robert Murphy tells us that it is not at all clear that we “should credit QE1 and/or [sc. the] Obama stimulus” with the US recovery in 2009. That reflects a most extreme view that some Austrians can now be found peddling: the idea that expansionary government fiscal policy does nothing or little to increase private investment and consumption, and that government stimulus programs do not work.

How strange it is, then, to see that other Austrians have never denied that government fiscal and monetary policies can increase employment and output.

Take this statement by Huerta de Soto (who is himself an advocate of a most extreme Rothbardian program):
“Under certain conditions, government and union intervention, along with the institutional rigidity of the markets, may prevent the necessary readjustments which precede any recovery of economic activity. If wages are inflexible, hiring conditions very rigid, union power great and governments succumb to the temptation of protectionism, then extremely high unemployment can actually be maintained indefinitely, without any adjustment to new economic conditions on the part of the original means of production. Under these circumstances a cumulative process of contraction may also be triggered. By such a process the massive growth of unemployment would give rise to a widespread decrease in demand, which in turn would provoke new doses of unemployment, etc. Some theorists have used the term secondary depression to refer to this process, which does not arise from spontaneous market forces, but from coercive government intervention in labor markets, products, and international trade. In some instances, ‘secondary depression’ theorists have considered the mere possibility of such a situation a prima facie argument to justify government intervention, encouraging new credit expansion and public spending. However the only effective policy for avoiding a ‘secondary depression,’ or for preventing the severity of one, is to broadly liberalize markets and resist the temptation of credit expansion policies. Any policy which tends to keep wages high and make markets rigid should be abandoned. These policies would only make the readjustment process longer and more painful, even to the point of making it politically unbearable.

What should be done if, under certain circumstances, it appears politically ‘impossible’ to take the measures necessary to make labor markets flexible, abandon protectionism and promote the readjustment which is the prerequisite of any recovery? This is an extremely intriguing question of economic policy, and its answer must depend on a correct evaluation of the severity of each particular set of circumstances. Although theory suggests that any policy which consists of an artificial increase in consumption, in public spending and in credit expansion is counterproductive, no one denies that, in the short run, it is possible to absorb any volume of unemployment by simply raising public spending or credit expansion, albeit at the cost of interrupting the readjustment process and aggravating the eventual recession.

Nonetheless Hayek himself admitted that, under certain circumstances, a situation might become so desperate that politically the only remaining option would be to intervene again, which is like giving a drink to a man with a hangover. In 1939 Hayek made the following related comments:
it has, of course, never been denied that employment can be rapidly increased, and a position of ‘full employment’ achieved in the shortest possible time by means of monetary expansion. ... All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations. There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for a short period—perhaps the situation in which Dr. Brüning found himself in Germany in 1932 was such a situation in which desperate means would have been justified. But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space.
Now let us suppose politicians ignore the economist’s recommendations and circumstances do not permit the liberalization of the economy, and therefore unemployment becomes widespread, the readjustment is never completed and the economy enters a phase of cumulative contraction. Furthermore let us suppose it is politically impossible to take any appropriate measure and the situation even threatens to end in a revolution. What type of monetary expansion would be the least disturbing from an economic standpoint? In this case the policy with the least damaging effects, though it would still exert some very harmful ones on the economic system, would be the adoption of a program of public works which would give work to the unemployed at relatively reduced wages, so workers could later move on quickly to other more profitable and comfortable activities once circumstances improved. At any rate it would be important to refrain from the direct granting of loans to companies from the productive stages furthest from consumption. Thus a policy of government aid to the unemployed, in exchange for the actual completion of works of social value at low pay (in order to avoid providing an incentive for workers to remain chronically unemployed) would be the least debilitating under the extreme conditions described above.” (Huerta de Soto 2012: 452–456).
First, before I come to my main point, Huerta de Soto is entirely wrong to blame “secondary depressions” solely on government intervention and “union power.” Has this man never heard of debt deflation and subjective expectations affecting the outlook of capitalists? In an environment of high private-sector debt, wage cuts would prove disastrous as the burden of debt soared, which causes bankruptcy to both debtors and creditors. And, in any case, markets lack the reliable equilibrating mechanisms so beloved by neoclassicals and Austrians, for the following reasons:
(1) the essential property of all highly liquid assets (with money as the most liquid asset) is that there is a zero or near zero elasticity of substitution between these liquid assets and producible commodities. This means that the gross substitution axiom is false and any acts of spending on liquid assets causing their price to rise will not necessarily induce substitution effects leading to more demand for cheaper producible commodities.

(2) it is unlikely that all markets have equilibrium prices (and even less likely that price setting businesses would be willing to adjust the prices rapidly anyway if they existed). The very notion of an economy with a tendency to general equilibrium, where all product markets converge to market-clearing prices, depends on unrealistic assumptions, such as flexible prices and demand and supply curves behaving with substitution effects in the absence of income effects;

(3) owing to uncertainty and subjective expectations, it is unlikely that shattered expectations of business people will change suddenly to induce the necessary level of investment in a severe recession or depression;

(4) there is thus no guarantee that savings will match investment (even if you assume a loanable funds theory of interest) or that Say’s law is much more than a fantasy;

(5) there is no such thing as some natural rate of interest that will equilibrate savings and investment;

(6) as Keynes himself argued, absence of wage and price flexibility is not the reason why neoclassical theory is flawed: even if we had complete wage and price flexibility, there would still be no guarantee of full employment.
But to return to my original point: the crucial issue here is that even Huerta de Soto states that “no one denies that, in the short run, it is possible to absorb any volume of unemployment by simply raising public spending or credit expansion” – no one, that is, except (apparently) Robert Murphy!

Curiously, Ludwig Lachmann went further than Huerta de Soto and saw public works spending in a depression as a genuinely useful measure:
“In the British situation of 1932, Hayek and his friends rejected the proposals of Keynes and some non-Keynesian British economists – that at the bottom of the depression the government should take certain steps, and so on. Hayek has now realised that that was wrong. That is to say, I think Austrians today would not reject all measures to relieve unemployment and increase employment, in a situation in which nothing really is scarce. And in this respect I think Austrians … would have … have ... learned.”

Huerta de Soto, J. 2012. Money, Bank Credit and Economic Cycles (3rd edn.; trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.


  1. Jan said: I think it´s time to rename "Murphy´s Law" to "Bob Murhys Law" ."Anything that Bob involved in, that can go wrong will go wrong".

  2. "In the simplest, as in the more sophisticated, neoclassical models of
    employment, unemployment is essentially caused by excessive real wages. In most of these neoclassical models, the constraint of effective demand is ignored, and those, like the French disequilibrium school, who have taken effective demand into account, have been pushed aside, away from the mainstream research fads. In addition, when, in their eagerness to introduce some realism in their models, either to respond to external critique or to squash new classical opponents, New
    Keynesian and post-Walrasian economists try to explain involuntary mass unemployment, they still retain the variants where full employment could be achieved only if real wages turned out to be lower.
    By contrast, post-Keynesian authors have emphasized the importance of effective demand constraints. The models based on Kaleckian foundations essentially show that high real wages are not an obstacle to full employment, and that quite the contrary, high real wages may help to generate an economy with both high
    standards of living and a small proportion of the labour force in the informal sector. Essentially, what all the post-Walrasian and post-Keynesian models show is that multiple equilibria should be considered as the rule, and single equilibria as the exception. In addition, the better equilibria cannot generally be achieved by laissez-faire and free market forces. They must be achieved with
    the help of government intervention and national institutions."

  3. But haven't we already established that Murphy uses GDP as a proxy measure of the wealth of a country in everything he writes but at the same time doesn't understand GDP accounting?

    Send Murphy Barro's article on Ricardian equivalence. Then at least his arguments will be logically coherent. In that he can argue that, say, consumption fell in 2010-2012 after the initial effects of the stimulus. Is this reflected in the data? No. But one step at a time.

    1. Jan said: If Mr Murphy need to catch up with Ricardian equivalence i also recommend him to at same time deal with the core of Austrian school,the Subjetive Value Theory and it´s assumed applicativity and relevance.Since he seems to prefer old books,i suggest a relatively old,but i think still worth reading, Gunnar Myrdal´s (1930),("The Political Element in the Development of Economic Theory, english 1953,Routledge & Kegan Paul,London)
      Myrdal writes:
      "Action is said to be a direct consequence of the hedonistic calculus only if it is rational.The whole psychological theory applies only to the economic man who is defined as a man who assesses pleasure and pain effects (note that their existence is thereby implied) at their true value and who always chooses that line of action which maximizes his net pleasure.Now this is the fundamental flaw of the hedonistic theory.(...) The theory is claimed to be correct in the sense that anybody who acts in accordance with it, acts as the theory claims he does. This is of course circular reasoning."p. 92).
      "Marginal utility theory attempted to give a hedonistic interpretation of value at a time when psychologists were
      abandoning hedonism in favour of a more realistic analysis.(…(This) indicates clearly the lack of contact between economics and psychology.(p. 81)
      and further:
      "For a criticism of subjective value theory it is not sufficient to say that hedonistic quantities are not measurable. They are measurable if we grant the psychological premises,since these premises already imply measurability.It can hardly be denied that the subjective theory of value is true if hedonistic psychology is true." (1930, p. 92)
      And more:
      "We cannot dismiss the subjective theory of value simply by saying that it cannot be reduced to quantitative terms.It can
      if the hedonistic explanation of human behaviour is correct.(...) The question is whether the claim of marginal utility
      theory to be an accurate explanation of human behaviour is justified." (1930, p. 97).

  4. This provides a great example of why learning economic history or the history of economic thought remains so important today. Many Austrians whom I know would likely be surprised to learn of these statements by Hayek and others. Unfortunately, as Austrians have tried to assimilate themselves with neoclassical economics, it appears much learning from the political economy era has been lost.

  5. Personally, I dont believe that unemployment is caused by excessive real wages, and I'm i neo-Friedmanite and sympathetic to the neoclassicals. I believe its caused by excessive hoarding of cash with a fixed supply of money. If all prices were flexible, (AND I MEAN EVERYTHING, debt too!) what would happen when nominal gdp contracts by 10% would be this, wages would fall by 10%, so would debts, AND SO WOULD THE cost of living. Real wages would remain unchanged from boom to bust. But what WOULD change is the value of cash balances, what pigou called the "real balance effect" Once prices would hit a bottom, then investment would commence, because everyone would expect prices to rise again in the future. In fact Keynes mentions this. (Im not sure where, help would be appreciated!) He mentions that one possible way for price deflation to generate a recovery would be for prices to fall relative to the future, in other words, to hit a definite bottom. (By the way, LK, this also takes care of uncertainty problems) .

    But since prices are not flexible,and debt is sticky and rigid. that deficit spending and printing money are valid tools to use. BUT THEY DON"T WORK BY CUTTING REAL WAGES!. Its a myth many neoclassicals have, even about their own tradtion In fact, its entirely possible for real wages to INCREASE. The mechanism by which inflation works is the "reverse" real balance effect, by cutting the value of cash hoarders holdings, by encouraging them to spend now, before everything gets more expensive later.

  6. " by cutting the value of cash hoarders holdings, by encouraging them to spend now, before everything gets more expensive later."

    And yet that isn't what happens. When people find things getting expensive they save even more - because clearly they will need more in the future.

    Cutting rates and 'inflation' doesn't appear to encourage spending. Security and feeling safe about the future encourages spending.

  7. "When people find things getting expensive they save even more .."


    Its difficult for many people to understand this, myself included!. But inflation in the absolute present does little or nothing to encourage spending, in fact it actively hinders it. It is EXPECTED FUTURE INFLATION that drives presnt spending. If i have cash in my pocket, and there are things I wish to buy because I expect things to get less expensive later, what happens with expected inflation is that I go out and buy now. I'm able to do so because prices haven't risen YET.