Tuesday, June 26, 2007

Economists Refusing To Do Math

Tyler Cowen doesn't seem to know that this discussion of the Marginal Product of Capital is nonsense.

Tyler Cowen also doesn't know that Austrian Business Cycle theory is mistaken.

Robert Barro seems to mistakenly think that one can legimately express production functions as functions of capital goods, measured in numeraire units.

Notice that Tyler Cowen and Robert Barro seem to be using these mistakes in applied and policy-oriented models. I do not see why I should pretend such nonsense has any credibility whatsoever.


Anonymous said...

"The Austrian school largely failed to become orthodoxy as first Keynesian demand management appeared to end the Depression and later monetarism blamed the Depression on inadequate attention to the money supply."

So the mauling that Hayek received from both Sraffa and Kaldor had no impact in the success of Keynesianism? And as for Monetarism, I'm surprised anyone takes that seriously enough to even mention it.

I know that Austrians rarely mention the awkward little fact that Hayek lost the theoretical battles of the 1930s, but it seems that they are not the only ones...

Still, what is the argument of the "Austrian" school? That business cycles are caused by banks creating excess credits and so artificially lowering the rate of interest below its "natural" (i.e., equilibrium) rate. Which is ironic for two reasons:

1. It assumes that if only banks did not act like capitalists, then capitalism would be fine.

2. That their whole "theory" of the business cycle is based on a concept, equilibrium, which they claim to oppose and argue does not apply to any real economy.

There are other contradictory aspects of the Austrian theory on the business cycle, but those two will do for now.

All in all, I'm not surprised that Keynesianism defeated Hayek in the 1930s. Nor am I surprised that some people are mentioning Austrian theory again now -- all that funding by business people for "free market" think-tanks and university posts seems to be paying off.


Gabriel said...

Iain, I'm somewhat in agreement with you... with a few exceptions... One bank, the Central Bank, rather than "banks" in general; that, plus that it's "natural" not "equilibrium" rate.

Anonymous said...

The "natural" rate of interest is what equates savings and loans, in other words an equilibrium value.

As for the central bank, that does not force banks to extend credit. The empirical evidence suggests that the central bank has to adjust to the actions of banks (at least in the short term). In other words, the money supply is endogenous and not set by the state. Remove the central bank, and banks still face the same competitive pressures which make them lower interest rates artificially.

If anything, the farce which was Monetarism should have convinced everyone that the central bank does not control the money supply nor credit.

Robert Vienneau said...

I'm with Iain. The "natural rate" of interest is an equilibrium rate.

Until recently, most economists agreed that one could find equilibrium relationships of interest while still claiming that the economy is never in an equilibrium. I think many Austrian school economists consistency misrepresent others (e.g., Walras) on this point.

I'm thinking of using the difficulty in understanding both sides of the Kaldor-Hayek debate as motivation of an investigation of the mathematical consistency of Austrian capital theory in my next version of my paper on Austrian Business Cycle theory.

Gabriel said...

It's a *sort* of equilibrium. Not the "usual" kind.

The Austrians would not describe their theory using the terminology of the mainstream, but having such terminology imposed on their theory might be interesting (if I understand your project).

Anonymous said...

"It's a *sort* of equilibrium. Not the 'usual' kind."

I'm at a lose for words. So it *is* an equilibrium rate? What does equilibrium mean? That the supply and demand for a commodity equate. What is the natural rate of interest? That which brings savings and loans into alignment, that is into equilibrium...

"The Austrians would not describe their theory using the terminology of the mainstream, but having such terminology imposed on their theory might be interesting."

I've noticed that the Austrians use words in, let me say, unique ways then get annoyed when everyone else uses the word in the normal way! I suppose that makes it easier to ignore criticism...

But for an ideology which stresses that any real economy is in dis-equilibrium they do make some strange exceptions, namely in the markets for credit and labour. In those the market is always in or near equilibrium (or at its "natural" rate, to use Smith's terminology). That this means there is no need to worry about unemployment or the business cycle in a "free market" capitalist economy is just a wonderful co-incidence!

One last thing. Kaldor was Hayek's follower. He even translated one of his books into English. Later Kaldor said that doing this helped him see the limitations of Hayek's analysis. Which was why Kaldor's critique was so powerful, I would suggest (and why Austrians rarely mention it).


Robert Vienneau said...

I don't know what Gabriel thinks he is talking about either.

The phrase "natural rate of interest" was used by Knut Wicksell, and it is an equilibrium rate.

Austrian school economists only came to see themselves as seperate from mainstream neoclassicals in the resolution of the socialist calculation debate. Mises and Hayek put forth the Austrian business cycle theory before this.

Not surprisingly, they echoed a lot that was mainstream neoclassical at the time. For example:

"One must not commit the error of believing that the static method can be used only to explain the stationary state of an economy, which, by the way, does not and never can exist in real life; and that the moving and changing economy can be dealt with only in terms of a dynamic theory. The static method is a method which is aimed at studying changes; it is designed to investigate the consequences of a change in one datum in an otherwise unchanged system. This is a procedure which we cannot dispense with." -- von Mises (1933, as quoted by Kurz and Salvadori)

I do not see myself as imposing mainstream terminology on Austrians. All those quotations in my paper show that I am taking Austrians at their word.