Robert P. Murphy, “Krugman on Mises on the Great Depression,” Mises Institute of Canada, January 28th, 2014I will deal with Joseph Salerno’s post elsewhere, and only focus on Murphy’s below.
Joseph Salerno, “Paul Krugman Attacks Ludwig von Mises: Another Win for Austrian Economics!,” Mises Economics Blog, January 28th, 2014
Murphy’s first substantive point is to claim that Krugman is wrong to assert that “von Mises, faced with the reality of depression, basically dropped Austrian business cycle theory.”
First, I did not say that Mises totally dropped his business cycle theory, and it is quite possible Krugman did not mean to imply this either (since he linked to my post), and Murphy has misinterpreted him.
In point of fact, I said that “it is interesting that Mises thought that his Austrian monetary theory of the cycle could not adequately explain the severity and length of the Great Depression” (and people can read my original post and verify that for themselves). That is, Mises was forced to look for other explanations, rather like Hayek when the latter suddenly discovered the evils of “secondary deflation” as an additional cause of the length of the Great Depression.
At any rate, Murphy then selectively quotes this passage from Mises:
“The crisis from which we are now suffering is also the outcome of a credit expansion. The present crisis is the unavoidable sequel to a boom. Such a crisis necessarily follows every boom generated by the attempt to reduce the ‘natural rate of interest’ through increasing the fiduciary media. However, the present crisis differs in some essential points from earlier crises, just as the preceding boom differed from earlier economic upswings. The most recent boom period did not run its course completely, at least not in Europe. Some countries and some branches of production were not generally or very seriously affected by the upswing which, in many lands, was quite turbulent. A bit of the previous depression continued, even into the upswing. On that account—in line with our theory and on the basis of past experience—one would assume that this time the crisis will be milder. However, it is certainly much more severe than earlier crises and it does not appear likely that business conditions will soon improve.Yes, Mises desperately tried to say that his ABCT still applied as an explanation of the boom and cause of the initial downturn, but look at how feeble Mises’s attempt is:
The unprofitability of many branches of production and the unemployment of a sizable portion of the workers can obviously not be due to the slowdown in business alone. Both the unprofitability and the unemployment are being intensified right now by the general depression. However, in this postwar period, they have become lasting phenomena which do not disappear entirely even in the upswing. We are confronted here with a new problem, one that cannot be answered by the theory of cyclical changes alone.” (Mises 2006 : 163–164).
(1) Mises admits that Europe did not experience a strong boom, and that on the basis of his own theory “one would assume that this time the crisis will be milder. However, it is certainly much more severe than earlier crises and it does not appear likely that business conditions will soon improve.” That is, his theory lacked predictive power about the course of the bust after 1929.So my original statement is right. But ultimately this point is not that important, because the ABCT is wrong for many reasons I have explained here.
(2) Secondly, Mises said that his theory could not explain the depth and length of depression in terms of the “unprofitability of many branches of production” and the high unemployment.
And Daniel Kuehn does a wonderful job here discrediting the Hayekian version of the Austrian business cycle theory, and most of his criticisms apply also to Mises’s original ABCT.
But next we come to Murphy’s hypocrisy. Murphy likes to present himself as great defender of Austrian economics, and rushes to defend the Austrian business cycle theory (ABCT) in his post, giving his devoted Austrian fans the impression that the beloved ABCT is safe and sound from the criticisms of that nasty ogre Krugman.
I, however, have actually read a great deal of Murphy’s work.
I direct readers to these fascinating writings by Murphy:
Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.Now what, you may ask, is the significance of this?
Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”
A substantial part of Murphy’s PhD (Murphy 2003: 58–177) is devoted to rejecting that theory generally accepted by Austrians called the “pure time preference theory of interest” and defending a monetary theory of the interest rate.
Murphy, like John Maynard Keynes and modern Keynesians, thinks that interest rates are a monetary phenomenon, and in this post even hails Keynes’ analysis in Chapter 13 of the General Theory as “brilliant”:
Robert P. Murphy, “Is Keynes from Heaven or Hell,” Free advice, 7 July 2011But the really important point is that Murphy’s paper “Multiple Interest Rates and Austrian Business Cycle Theory” is about as damning a critique of the classical Austrian business cycle theory (dependent on Wicksell’s natural rate of interest) as you will find.
Murphy accepts that the Austrian business cycle when it is based on Wicksell’s unique natural rate of interest is a flawed theory and cannot work in that form.
This is quite clear when Murphy comments on Hayek’s debate with Piero Sraffa:
“In his brief remarks, Hayek certainly did not fully reconcile his analysis of the trade cycle with the possibility of multiple own-rates of interest. Moreover, Hayek never did so later in his career. His Pure Theory of Capital (1975 ) explicitly avoided monetary complications, and he never returned to the matter. Unfortunately, Hayek’s successors have made no progress on this issue, and in fact, have muddled the discussion. As I will show in the case of Ludwig Lachmann—the most prolific Austrian writer on the Sraffa-Hayek dispute over own-rates of interest—modern Austrians not only have failed to resolve the problem raised by Sraffa, but in fact no longer even recognize it.Murphy then discusses Lachmann’s (1994: 154) solution to Sraffa’s critique, but finds it wanting:
“Austrian expositions of their trade cycle theory never incorporated the points raised during the Sraffa-Hayek debate. Despite several editions, Mises’ magnum opus (1998 ) continued to talk of ‘the’ originary rate of interest, corresponding to the uniform premium placed on present versus future goods. The other definitive Austrian treatise, Murray Rothbard’s (2004 ) Man, Economy, and State, also treats the possibility of different commodity rates of interest as a disequilibrium phenomenon that would be eliminated through entrepreneurship. To my knowledge, the only Austrian to specifically elaborate on Hayekian cycle theory vis-à-vis Sraffa’s challenge is Ludwig Lachmann.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 11–12).
“Lachmann’s demonstration—that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest—does not establish what Lachmann thinks it does. The rate of return (in intertemporal equilibrium) on all commodities must indeed be equal once we define a numéraire, but there is no reason to suppose that those rates will be equal regardless of the numéraire. As such, there is still no way to examine a barter economy, even one in intertemporal equilibrium, and point to ‘the’ real rate of interest.”So there you have it.
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 14).
Wicksell’s natural rate does not exist, yet Hayek’s ABCT and Mises’s original ABCT in the form he held it in the 1930s uses the natural rate, as can be seen in Mises’s original 1931 paper that I originally quoted:
“According to the circulation credit theory (monetary theory of the trade cycle), cyclical changes in business conditions stem from attempts to reduce artificially the interest rates on loans through measures of banking policy—expansion of bank credit by the issue or creation of additional fiduciary media (that is banknotes and/or checking deposits not covered 100 percent by gold). On a market, which is not disturbed by the interference of such an ‘inflationist’ banking policy, interest rates develop at which the means are available to carry out all the plans and enterprises that are initiated. Such unhampered market interest rates are known as ‘natural’ or ‘static’ interest rates. If these interest rates were adhered to, then economic development would proceed without interruption—except for the influence of natural cataclysms or political acts such as war, revolution, and the like. The fact that economic development follows a wavy pattern must be attributed to the intervention of the banks through their interest rate policy. ….It follows that if Murphy were intellectually honest and not an evasive shill for his fellow Austrian economists, he would graciously concede that his own published work entails that he himself appears to accept that the classical Austrian business cycle theory per se (using the natural rate) cannot explain recessions or depressions.
At the interest rates which developed on the market, before any interference by the banks through the creation of additional circulation credit, only those enterprises and businesses appeared profitable for which the needed factors of production were available in the economy. The interest rates are reduced through the expansion of credit, and then some businesses, which did not previously seem profitable, appear to be profitable.” (Mises 2006 : 161).
Krugman is right in rejecting the classical Austrian business cycle theory, even if not for the reasons that Murphy does.
Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London.
Mises, Ludwig von. 2006 . “The Causes of the Economic Crisis,” in Percy L. Greaves (ed.). The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala. 155–181.
Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.
Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”