Catalán, Straw Man Arguments and Mises’s View of Equilibrium

Jonathan F. Catalán responds to my last post here:

Jonathan Finegold Catalán, “Sloppy Interpretations,” Economic Thought, 9 June, 2012.

It is unfortunate that the response is attacking nothing but a straw man version of my arguments. This is easily demonstrated, as follows:

(1) Catalán says:

“... blogger ‘Lord Keynes’ unconvincingly continues the argument that Mises was predominately an equilibrium economist.”

I say no such thing. I do not deny that Mises was different from neoclassical economists on the position of equilibrium. I have always accepted that Mises never thought that the ERE or a state of general equilibrium is ever reached in the real world.

(2) Catalán says:

“The world of equilibrium is a world without change; it is purely imaginative. ‘Lord Keynes’ fails to recognize that the evenly rotating economy, as used by Mises, is merely an explicitly fictitious mental construct meant to derive the origins of certain economic relationships. It is nothing more than an ideal type. In the real world, replete with constant change, this fictitious relationship obviously fails to hold.”

I have never asserted that Mises thinks that the ERE is a real world phenomenon. Catalán has simply made this up. In fact, nearly a year ago I wrote a post on Mises’s concepts of equilibrium, and explicitly recognised that, for Mises, the ERE is a fiction:

“Mises’s Three Concepts of Equilibrium,” June 23, 2011.

(3) What I assert is that Mises believed in a “strong tendency towards general equilibrium as a real phenomenon of the market economy,” although the actual state is never reached.

Belief in a tendency to equilibrium is completely compatible with the view that Mises believed that an actual equilibrium state is never reached. I take it that Catalán can understand the difference between (1) a tendency towards general equilibrium, and (2) actual equilibrium as a real world state.

This is exactly what Ludwig Lachmann was saying here:

“Professor Hayek and Mises both espouse the market process, but do not ignore equilibrium as its final stage. The former, whose early work was clearly under the influence of the general equilibrium model, at one time appeared to regard a strong tendency towards general equilibrium as a real phenomenon of the market economy. Mises, calling the Austrians ‘logical’ and neoclassicals ‘mathematical’ economists, wrote: ‘Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease’ ... It is this view of the market process as at least potentially terminating in a state of long-run general equilibrium that now appears to require revision.

In a kaleidic society the equilibrating forces, operating slowly, especially where much of the capital equipment is durable and specific, are always overtaken by unexpected change before they have done their work, and the results of their operation disrupted before they can bear fruit. Restless asset markets, redistributing wealth every day by engendering capital gains and losses, are just one instance, though in a market economy an important one, of the forces of change thwarting the equilibrating forces. Equilibrium of the economic system as a whole will thus never be reached. Marshallian markets for individual goods may for a time find their respective equilibria. The economic system never does. What emerges from our reflections is an image of the market as a particular kind of process, a continuous process without beginning or end, propelled by the interaction between the forces of equilibrium and the forces of change. General equilibrium theory only knows interaction between the former.” (Lachmann 1976: 60–61).

“Potentially terminating in a state of long-run general equilibrium” is Lachmann’s way of referring to a tendency towards general equilibrium, not the state of equilibrium itself (or the ERE). Even Lachmann’s “equilibrating forces,” I would argue, should be distinguished from a fundamental and strong tendency of the real world market to general equilibrium, because the “equilibrating forces,” as Lachmann says, are thwarted by change, uncertainty and subjective expectations of economic agents which are liable to shift. If the “equilibrating forces” did in fact work consistently and in a reliable way, there would be a strong tendency to general equilibrium in market economies. But they do not.

Once the distinction between

(1) a tendency towards general equilibrium, and
(2) actual equilibrium as a real world state

is understood, some kind of serous argument is possible.

But straw man arguments refute nothing.


BIBLIOGRAPHY

Lachmann, Ludwig M. 1976. “From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society,” Journal of Economic Literature 14.1: 54–62.

Catalán on the Wicksellian Natural Rate of Interest

I direct readers again to the ever interesting Jonathan Finegold Catalán, and his new post on the Wicksellian natural rate of interest and how Mises abandoned it:

Jonathan Finegold Catalán, “Malinvestment and Interest,” Economic Thought, 18 May, 2012.

Two points:

(1) At the end of his post, Catalán asserts:

“This does not mean that rate of interest is unimportant; just that Austrian capital theory does not hinge on the concept of a “natural rate of interest.”

Well, Austrian capital theory might not, but what about the Austrian business cycle theory (ABCT)? For Roger Garrison, the leading modern exponent of ABCT, uses the concept called a “market-clearing or equilibrium rate,” and he appears to mean by it the natural rate of Hayek:

“The supply and demand for loanable funds … identify a market-clearing, or equilibrium, rate of interest ..., at which saving (S) and investment (I) are brought into equality.” (Garrison 2000: 39).

On that same page in Time and Money: The Macroeconomics of Capital Structure (2000), Garrison makes it clear that this rate is essentially the Wicksellian rate causing intertemporal equilibrium or dis-equilibrium.

One can also read Garrison’s “Natural and Neutral Rates of Interest in Theory and Policy Formulation”:

“So named by Swedish economist Knut Wicksell, the natural rate of interest is the rate that reflects the underlying real factors. .... the natural rate guides the economy along a sustainable growth path. That is, governed by the natural rate, unconsumed current output (real saving) is used for augmenting the economy’s productive capacity in ways that are consistent with people’s willingness to postpone consumption. In the hands of the Austrian economists, the natural rate became the rate that reflects the time preferences of market participants and allocates resources among the temporally defined stages of production. The output of one stage serves as input to the next in this logical and broadly descriptive representation of the economy’s production process. The temporal dimension of the economy’s capital structure is a key macroeconomic variable in Austrian theory. .... In summary terms, the natural rate is seen as an equilibrating rate. It is the rate that tells the truth about the availability of resources for meeting present and future consumer demands, allowing production plans to be kept in line with the preferred pattern of consumption. By implication, an unnatural, or artificial, rate of interest is a rate that reflects some extra-market influence and that creates a disconnection between intertemporal consumption preferences and intertemporal production plans” (Garrison 2006: 58–59).

What are we to make of an Austrian theory whose leading theorist still embraces a non-existent, Wicksellian natural rate?

(2) Catalán asserts:

“... the crucial aspect of Austrian capital theory is not the derivation of the rate of interest but, in Sraffian terms, the inducement of severe intertemporal resource misallocation. The underlining requirement for Austrian business cycle — and this is clear even in Hayek’s Prices and Production — is an increase in the stock of money representing savings and the distribution of this money to entrepreneurs. This is why, in Human Action, Mises gives more weight to fiduciary expansion than the rate of interest.”

But what happens when the economy is in a state of idle capital goods, mass unemployment and idle resources? But then the following logically follows:

“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.”

Click on the link to see what horrible enemy of freedom said this, or go here or here and read more (hint: it wasn’t Paul Krugman!).

When Catalán states that “Mises gives more weight to fiduciary expansion than the rate of interest,” then presumably fiduciary expansion is also a more important cause of an Austrian business cycle (ABC) than the interest rate. Clearly, this requires that fiduciary expansion is a sufficient cause for an ABC.

Does this not contradict Catalán’s earlier post? We are supposed to believe that a free banking system would avoid over-expansion of credit, but, as I have shown here, a real world case that approximates the free bankers’ utopia – Australia in the 19th century – does not support their idea at all.

BIBLIOGRAPHY

Garrison, R. W. 2000. Time and Money: The Macroeconomics of Capital Structure, Routledge, London and New York.

Garrison, R. W. 2006. “Natural and Neutral Rates of Interest in Theory and Policy Formulation,” Quarterly Journal of Austrian Economics 9.4: 57–68.

Debunking Catalán on the Recession of 1937-1938

Jonathan M. Finegold Catalán attempts to prove that the recession of 1937–1938 was not caused by contractionary fiscal and monetary policy:

Jonathan M. Finegold Catalán, “Dangerous Lessons of 1937,” Mises Daily, February 2, 2010.

I. The Data
First, some basic facts about the recession and data:

(1) In the US, the fiscal year before 1976 ran from July 1 to June 30 in the next year. So in the relevant years the actual fiscal years were as follows:

Roosevelt inaugurated March 4, 1933.
Fiscal 1934: July 1, 1933 – June 30, 1934
Fiscal 1935: July 1, 1934 – June 30, 1935
Fiscal 1936: July 1, 1935 – June 30, 1936
Fiscal 1937: July 1, 1936 – June 30, 1937
Fiscal 1938: July 1, 1937 – June 30, 1938
Fiscal 1939: July 1, 1938 – June 30, 1939
Fiscal 1940: July 1, 1939 – June 30, 1940

In analysing the effects of fiscal policy in these years, one should not confuse the calendar year with the fiscal year: these are two different things.

(2) The actual recession (economic contraction) ran from May 1937 to June 1938.¹ Thus the contraction began in the last months of fiscal year 1937 and lasted until the end of fiscal year 1938.

(3) Data on the Federal budget can be found here:

Federal Budget Receipts and Outlays: Coolidge – Obama.

(4) Data on total government spending (including local, state and federal) can be found here:

Total US Government Spending in billions of dollars.

The figures on total government spending (state, local, federal):

Year Outlays
1933 $12.62
1934 $12.81
1935 $14.78
1936 $16.76
1937 $17.22
1938 $17.68
1939 $19.05
1940 $20.42

Now these figures do not show us whether increases in total government spending were expansionary or contractionary, as one needs to look at whether the spending increases occurred by deficit spending or merely out of current revenues.

II. Critique
Let us now refute and correct Catalán’s assertions and errors here:

(1) Catalán states that

“The idea that Herbert Hoover was a laissez-faire president and that Roosevelt's New Deal paved the road to recovery have been refuted elsewhere.”

I have already refuted the Austrian attempts to paint Herbert Hoover as some radical interventionist president or big-spending Keynesian here:

“Herbert Hoover’s Budget Deficits: A Drop in the Ocean,” May 24, 2011.

Hoover adopted some very limited policy interventions and very mild increases in federal government spending from 1929–1932, but these were almost completely destroyed by state and local austerity.

(2) Catalán states that

“Interestingly, during 1935 — a year considered one of recovery — total government outlays measured $6.4 billion, less than during both 1936 and 1937. In fact, looking back to the years from 1933 to 1935, government spending peaked at $6.5 billion in 1934. It suffices to say that explaining Roosevelt's recession by pointing at a decrease in government spending is severely dishonest.”

Catalán commits the red herring fallacy, and is laughably ignorant of basic Keynesian theory: to gauge the effects of fiscal policy in any particular year and to see whether it was expansionary or contractionary, one must look at

(1) the size of the deficit and whether there was increased spending done via deficits, not just the size of spending per se;
(2) whether tax policy changed and if revenues rose owing to tax increases, and
(3) not just federal spending by itself, but total government spending at the local, state and federal level, to see if the net effect of deficit spending was expansionary.

In fact, total government spending in fiscal years 1935 and 1936 was highly expansionary:

Year* Total Outlays
1933 $12.62
1934 $12.81
1935 $14.78
1936 $16.76
1937 $17.22
1938 $17.68
1939 $19.05
1940 $20.42
*the fiscal year

The expansionary effect of fiscal policy in these years must be attributed to the large federal deficits. In fiscal year 1934 there had been a large deficit, but its expansionary effect was reduced to some extent by state and local austerity. In the fiscal years 1935 and 1936 federal deficits overcame that state and local austerity and imparted significant stimulus at a time when the financial system had been stabilised and monetary policy aided recovery.

It is no surprise that GDP soared in these years, with growth rates of 8.1% (1935) and 14.1% (1936). In 1937 and 1938, Roosevelt turned to budget balancing: the result was that federal deficit was virtually eliminated by fiscal year 1938 by

(1) the raising of taxes (which contracted private spending power), and
(2) reducing overall federal spending.

This shows up in the figures above for total government spending for 1937 and 1938, where total spending barely moved, and was at any rate offset by contractionary state and local fiscal policy, as in 1934 (Cary Brown 1956: 867–868).

In fact, the role of state and local governments during the depression was deeply contractionary most of the time:

“The nation’s fiscal policy throughout the Great Depression included the fiscal actions of state and local governments as well as of the federal government. During the early years of the depression, state governments increased spending for unemployment relief, primarily through subventions to local governments, which faced sharply declining property tax revenues, soaring rates of default, and even popular revolts, including a tax strike in Chicago. They did so by increasing sales taxes and by reducing spending on public works, especially highways, and schools. State constitutions, however, limited deficit finance, and new state and municipal bonds were extremely difficult to market. As the Depression worsened in 1931 and 1932, state and local governments found it impossible to conduct business as usual and still balance their budgets. State and local governments began adopting drastic economies, scaling back total expenditures in 1931 and sharply contracting them in 1933 and 1934. State governments welcomed federal funding of unemployment relief and public works, although they resisted the requirement of the Federal Emergency Relief Administration and the PWA for state matching funds. When economic recovery advanced, particularly in 1936 and 1938, state and local governments resumed spending on public works and education and thus once again increased their total outlays. Sharp increases in tax rates, however, erased any stimulative effect of state and local spending. State and local governments had pushed up tax rates every year between 1929 and 1933, and maintained those high levels until 1936, when they undertook even further increases. State governments increased the scope and rates of their sales taxes until, in 1940, they raised most of their funds through such levies.” (Elliot Brownlee 2000: 1044).

What was also deeply contractionary was the fact that state and local governments were running surpluses:

“Over the same seven years [sc. 1932–1938], state and local government revenues increased—principally from higher taxes—at a faster rate than expenditure.” (Bagwell and Mingay 1987: 282).

What the figures for total government spending (state, local and federal) from 1937–1938 tell us is that, while state and local governments did increase spending (which led to an overall increase in total government spending in each year), they

(1) did so by raising taxes (which did not stimulate the economy), and

(2) they even ran surpluses, which drained even more spending power from the economy, an astonishingly anti-Keynesian thing to do at a time when the economy needed countercyclical fiscal policy.

State and local government contractionary fiscal policy in 1937 and 1938 was thus caused by (1) raising taxes and (2) running surpluses.

The net effect of government fiscal policy in 1937 was to cause “a shift in demand of over [2.5] per cent of GNP in one year” (Cary Brown 1956: 866).

Catalán also ignores the following:

(1) in June 1936, the Revenue Act passed Congress and caused a significant increase in income tax rates, as well as the tax on undistributed profits. The main effect of the tax on undistributed profits was to adversely affect the cost of investment for small and medium-sized firms. There is a reasonable case to be made that this tax increased business uncertainty about profitability of investment.

(2) collection of the Social Security tax began in January 1937, another tax measure contracting private spending power.

(3) The Fed increased Reserve requirements on July 14, 1937 and this went into effect the next month; the second and third increases in reserve requirements were announced on January 30, 1937, and came into effect on March 1 and May 1 respectively. From December 1936, the treasury began to sterilise gold inflows into the United States by using proceeds of bond sales to pay for gold brought to the treasury. From December 1936 to February 1938 the monetary base grew by only 4% while gold stock grew by 15%.

The tax increases reduced the federal deficit very significantly indeed by fiscal year 1938, by causing revenues to rise. The net effect of all this when combined with federal spending cuts was highly contractionary: this was the cause of the 1937–1938 recession.

(3) Catalán ignores the fact that the Federal deficit was almost abolished in fiscal year 1938. Catalán states:

“It is not much more useful to look at deficit spending. True, deficit spending in 1937 was at its lowest since 1933, but it is worth mentioning that in 1938 — the same year as the economy rebounded from the 1937 dip — total government deficit spending amounted to only $89 million.”

In a strange non sequitur Catalán notes in passing that the deficit was massively reduced in fiscal year 1938 (July 1, 1937 – June 30, 1938): in fact, it was virtually eliminated and caused contractionary fiscal policy. The deficit in fiscal year 1938 was the lowest ever in all the years from 1931–1941. In terms of its fiscal impact, the federal budget was almost balanced in fiscal year 1938.

Catalán also confuses the fiscal year with the calendar year. Some data:

(1) The actual recession (economic contraction) ran from May 1937 to June 1938.

(2) Fiscal years:
Fiscal 1937: July 1, 1936 – June 30, 1937
Fiscal 1938: July 1, 1937 – June 30, 1938
Fiscal 1939: July 1, 1938 – June 30, 1939.

The recovery began in July 1938, which is in fiscal year 1939. Most of the actual recession coincided with fiscal year 1938, precisely the year when the deficit had been nearly abolished.

It was only in about April 1938 that Roosevelt turned once again to expansionary fiscal policy and ended the austerity programs. It was no surprise that some months later the recession ended, and economy began to grow again, and entered another expansionary phase of real GNP growth, as the federal deficit soared to $2.8 billion in fiscal year 1939 (July 1, 1938–June 30, 1939).

FOOTNOTES
(1) There seems to be some disagreement about when the recession ended. Cf. Gene Smiley (1997: 154), who states that the recession lasted from May 1937 until August 1938. The official NBER chronology, however, shows a recession from May 1937 to June 1938.

BIBLIOGRAPHY

Bagwell, P. S. and G. E. Mingay, 1987. Britain and America 1850–1939: A Study of Economic Change (2nd edn.), Routledge, London.

Cary Brown, E. 1956. “Fiscal Policy in the ’Thirties: A Reappraisal,” American Economic Review 46.5: 857–879.

Elliot Brownlee, W. 2000. “The Public Sector,” in S. L. Engerman and R. E. Gallman (eds), The Cambridge Economic History of the United States. Volume 3. The Twentieth Century, Cambridge University Press, Cambridge. 1013–1060.

Gene Smiley, W. 1997. “Depression of 1937–1939,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia, Garland Pub., New York. 154–155.