Saturday, August 3, 2013

Response to Jonathan Finegold Catalán on the Austrian Business Cycle Theory

Jonathan Finegold Catalán has a response to me on the Austrian Business Cycle Theory here:
“Producers’ Goods Prices,” Economic Thought, 3 August, 2013.
First, regarding Catalán’s graphs, that movement in the prices of capital and intermediate goods occurs is not in doubt! These graphs are not necessarily showing us that prices are moving in response to demand changes. I suspect Catalán has misunderstood the meaning of “administered fixprices.” That expression does not mean prices never or rarely change.

The point is that, in administered fixprice markets, prices generally change because of changes in factor input costs, not because of short or medium term changes in demand. That should be perfectly apparent in the spikes in prices in these graphs from the mid and late 1970s, at times when the Western world was in recession, but which saw supply side inflation from the oil shocks.

These graphs do not refute my assertion about the importance and widespread existence of administered fixprices in any modern capitalist economy.

I respond to Catalán’s specific points below:
(1) Catalán says that there is “such [sc. a] thing as an equilibrium rate that we can conceptualize” (my emphasis). Yes, there is, but it is only marginally more significant to economics than the fact that we can conceptualise magical unicorns, flying dragons, or any number of other non-existent imaginary things or entities.

An imaginary Wicksellian natural rate existing only in a fictitious world of general equilibrium or Mises’s “final state of rest” is effectively worthless and irrelevant to real world economics. Why? The reason is that (1) general equilibrium cannot exist and (2) it is real rate applicable only to a barter world.

Catalán asserts that we “can use this equilibrium rate as a reference point when judging policy.” No, we cannot.

The mythical rate is irrelevant to policy. Only if Catalán posits and defends the view that the real world has a tendency towards such a rate would the natural rate have some relevance to economics. But Catalán has proven no such thing.

(2) Catalán says:
“Early versions of ABCT are movements between equilibria: Yes, LK, welcome to the world of modeling, where you abstract from certain realities to be able to focus on the aspects that you want to explain.”
But not at this level of inaccurate abstraction: Catalán wants to explain the real world by reference to non-existent transitions between equilibrium states that do not occur in the real world.

I contend that such models have no worthwhile application to the real world in explaining real world business cycles.

(3) With Austrian capital theory, we are back to the question of unrealistic “ideal types” and models.

For a more detailed demonstration of flaws in Austrian capital theory and problems with the alleged “lengthening” of the capital structure, I refer readers to these discussions:
Vienneau, R. L. 2006. “Some Fallacies of Austrian Economics,” September

Vienneau, R. L. 2010. “Some Capital-Theoretic Fallacies in Garrison’s Exposition of Austrian Business Cycle Theory,” September 4
(4) On loanable funds theory, I appear to get this concession:
“I agree that interest should play less of a role in ABCT than it does in a lot [sc. of] narratives. But, if you read, say, The Pure Theory of Capital, you’ll see that the rate of interest is actually not vital to ABCT, at all.”
Then why does the loanable funds theory appear in so many modern versions of ABCT today like Roger Garrison’s?

And even appeals to Hayek’s later versions of the ABCT where he switched to “false profits” simply beg the question by assuming the truth of this new model. It must face serious problems precisely because of the issue of administered prices.

(5) On the tendency to equilibrium, Catalán says:
“Again, take equilibrium as a reference point. What people mean when they say there’s a tendency towards equilibrium is that entrepreneurs are interested in chasing profits and liquidating unprofitable investments (except under certain conditions).”
It is very difficult to see how this is not a fallacy of equivocation.

No, a tendency towards equilibrium is simply not a state where “entrepreneurs are interested in chasing profits and liquidating unprofitable investments.” This is a bizarrely thin definition of a “tendency towards equilibrium.”

Catalán has changed the definition of “equilibrium” away from what Austrians normally mean by it. The Austrian view of a tendency towards equilibrium would at least stress:
(1) flexible prices moved toward their market clearing levels to equate demand with supply;

(2) a tendency towards the equalisation of profits, and

(3) a tendency toward the equalization of the “originary interest” rate for all commodities.
But I have had this discussion with Catalán before.

In his in previous posts, he implies that he himself does not think there is a real world tendency towards a general equilibrium state (whether Walrasian GE or Misesian “final state of rest”), and at one point implied that Mises was almost a radical subjectivist.

Now it is obvious that a tendency towards market-clearing prices is at least one fundamental element of the Austrian idea of a tendency towards equilibrium and economic coordination, yet this is precisely the element that is grossly unrealistic, given the wealth of data on modern administered prices.
Catalán then says this of my original criticisms:
“these are very weak criticisms of ABCT and they shouldn’t be taken seriously. Some of the ‘criticisms’ raised are actually strong points in the theory, because they’re issues that Austrian capital theorists have dealt with at length before.”
Oh, really?

So there are versions of the ABCT that take account of fixprices? Of the severe problems in thinking that loanable funds theory is accurate in its assumptions about the information communicated about time preference?

Why, then, does the major exposition of the ABCT in recent times by Roger Garrison use a natural rate?

Finally, I get no real discussion of why fixprices would render the “false profits” version of ABCT highly unlikely, given that the alleged price movements causing these “false profits” would be largely non-existent.

Update: Response to Catalán’s Comments

My response to Catalán’s new criticisms in the comments section:
(1) No, I said that the single Wicksellian natural rate, a real rate, it is rate applicable only to a barter world in equilibrium. And I have a hard time seeing how that is not true.

I most emphatically do not deny the importance of good models. What is being asserted above is that these general equilibrium models are effectively irrelevant to the real world as explanations or guides to real world business cycles. This is a different thing from what you are accusing me of.

(2) Once the equilibrium conditions of Hayekian ABCT are lifted and all the other unrealistic assumptions I have discussed in the original post are taken account of, the relevance of ABCT to the real world becomes effectively zero. There is little reason to expect business cycles to be explained by ABCT.

(3) No, the Austrian capital theory literature has not responded to Vienneau.

(4) So Roger Garrison’s Time and Money: The Macroeconomics of Capital Structure (2000), which Austrians (I am fairly sure) regard as one of the fundamental treatments of the ABCT in modern times, has “an interpretation of the theory” that is incorrect? Is Catalán aware of what a stunning concession to me this is? It validates his claim that my original criticisms were “weak” and “shouldn’t be taken seriously” for one.

(5) If Catalán agrees with accepted Austrian views of a tendency to equilibrium, then he has still not proven this tendency. In fact, his statements in (6) clearly recognise the existence of administered prices, and that must mean the real world has a fairly strong impediment to equilibrium in the Austrian sense by failure of adjustment to market-clearing prices in so many markets.

(6) The existence of both flexprice and fixprice markets in the primary commodities sector and others is not in doubt. Perhaps I have not made myself clear: of course, flexprice markets exist.

My comments at the beginning of this post question to what degree these capital markets are flexprice, in the sense of being rapidly flexible in response to demand changes. The graphs do not answer that question. A good many manufactured capital goods, for example, are likely to be fixprice.


  1. I responded back in the comments section of my post.

  2. Oh dear, it always goes a bit south when the Austrians try to use data. Here, LK, maybe do a post with this one graph that refutes Catalan:

    I'm not sure you even need to write anything...

  3. I have a question. Supporters of administered prices think that only some prices are administrated, others (such as most raw materials) are set by supply and demand , right ?

    So when you say "The point is that, in administered fixprice markets, prices generally change because of changes in factor input costs, not because of short or medium term changes in demand" you are implying that all price changes are driven by things that happen in non-administered markets and that if all markets were administered there would be no reason for prices ever to change ?

    Is that correct ? Ow would supply-side factors sometimes cause price changes even in fix price ?

    1. Of course price changes in flexprice factor input goods/commodities markets can cause price changes in fixprice markets.

      Ow would supply-side factors sometimes cause price changes even in fix price ?

      Didn't I just say this above? In fact, it was one of the causes of stagflation.

  4. Here, I did it...

  5. I an unclear by what you mean by administered prices. From your earlier post what I think you mean is production cost plus a markup if that is the case how do you handle the following:
    1) Freight – In on raw material inventory is that part of production cost in term of prices for a manufacturing firm? Some place I worked for have it as part of production cost, other do not.
    2) Quality department same question?
    3) SG&A cost, for example the accounting department is that production cost?
    Most prices from what I experience are market driven and not based on cost, the proof is there are vastly different gross profit percentage variances on various parts. In other words price takers and not price makers.
    Why no analysis on write off of inventory. I would believe the success of market reaching equilibrium would be based on the extend of inventory having to been written off because of a lack of buyers
    In my experience manufacturing capital goods are not fixed price but instead are based on negotiate. For example my company was able to make a fixed asset purchase for $150K instead of the original selling price of $200K
    For all of your talk of being in the real world you sure are vague in your empirical statements. I asked that you join me in going to individual companies, may I suggest DuPont who I have dealing with to start the analysis.