Wednesday, October 16, 2013

Austrians bite back

I thought I'd post an Austrian reply to Mr Roche's blog "Why Austrian Economics is Flawed". Here goes:

1. Is Austrian economics a school or a political ideology masquerading as a science?

First, Mr. Roche starts off with a misrepresentation of what it means to be an "Austrian". He seems to confuse or conflate the school with some of its members. He neglects the fact that the Austrian school is made up of peoples with very different political views. Some Austrians like Hayek supported all sorts of government interventions in the market such as the minimum wage all the way to healthcare. Other Austrians like Mises thought that government should intervene less, but still has a role in society. There are even some Austrians that don't believe in any kind of government. But all of that is beside the point. Austrian economics is a value free science. It describes the economic effects of policy. Whether those effects are "good" or "bad" from a value perspective differ from Austrian to Austrian. For example, the school may describe the effects of a minimum wage was a cause of more unemployment in specific demographics than otherwise would be. This did not persuade Hayek from supporting it. After Mr Roche begins by smearing the Austrian school, he misrepresents another Austrian position:
There is always an excuse within Austrian Economics that implicitly assumes government cannot spend dollars any better than a household. This might be true in a general sense, but it is not always true. For that implies that households and businesses always make rational decisions.
I don't think this is an accurate representation of the Austrian position. Austrians recognize that government spending on scarce resources removes those resources from potential usage by the private market. Even in the best case, if those resources are idle there still will be an impact on prices. Cosmo Kramer illustrates this well here:
10 heads of lettuce on store shelves has an effect on the relative price of lettuce. 10 unemployed people has an effect on wage rates.
So government spending does have an effect on prices of assets and other resources. To determine the value of government spending, we need to compare it to the way the market allocates resources. The market relies on the price mechanism to allocate scarce resources according to the needs and wants of society. Prices that properly indicate the scarcity of resources relative to the wants of society emerge as a result of the existence of money, private property and voluntary exchange. The state operates outside of society. It has special privileges that the rest of society doesn't. For instance, it is the monopoly issuer of money, something that would be called "counterfeit" if you or I were to do it. It can also coerce property transfer to the state (taxes). Because the state operates outside society, its spending may or may not reflect the needs or wants of society while society's spending, by definition must. In short, the position is thus: because the state operates under different terms than society, state spending may or may not reflect the wants needs of society where individuals buying iPhones by definition does.


According to Mr Roche, the Austrians that predicted future housing trouble because of fed produced low interest rates in 2001 were utter failures in 2004 when housing prices were accelerating and the market was booming. This is essentially what Mr Roche does by saying today, the Austrians are wrong to predict inflation as a result of QE. Sure, if you measure inflation only by consumer prices, no, there has not been a huge increase in prices. But this is easily explained by even MMT-advocates. Consumers are so debt burdened that the acceleration necessary to produce inflation is absent. However, looking at the acceleration in stocks, bonds and other assets, it's clear there is price inflation in those areas. Michael Hudson reiterates this idea in the first 2 mins of this video. This observation plays into the Austrian money is non-neutral theory: inflation doesn't fall like snow on consumer prices. It falls in chunks in multifarious places around the economy. If you are measuring inflation only by the CPI, which doesn't include stocks, bonds, or real estate, you could say there is no inflation, but there clearly is price inflation in those areas. He then states:
Yes, the central bank controls a component of the interest rate that helps determine the spread at which banks can lend, but the central bank does not determine the rate at which banks borrow to customers.
To be technical, the fed doesn't set any rate. It only influences rates. To influence the Federal Funds Rate (FFR), the fed purchases or sells assets from primary dealers and credits/debits their reserve accounts. The federal funds rate has influence on lots of other interest rates like the WSJ Prime Rate. According to Bankrate:
The prime rate is the underlying index for most credit cards, home equity loans and lines of credit, auto loans, and personal loans. Many small business loans are also indexed to the Prime rate.
So unless is guilty of "outdated gold-standard thinking", the FFR does have an effect on rates Banks make to people. Therefore, it does affect market decisions on whether or not to start long term projects now because rates are low or to wait. I'm not saying the interest rate is the only signal to investors, but it is an important one.

3. Inflation

He is accurate that Austrians distinguish between price inflation and monetary inflation. But this does not, as Roche claims, mean that Austrians ignore that the private market is where most money is created. Many Austrians are very critical of the private banking system as it exists today. He claims that:
Austrians, in their fervor to demonize the fiat money system, make several errors here. First, they assume the government controls the money supply (which they don’t). It’s actually controlled primarily by private banks in a market system that Austrians should love.
Apparently he never read any Rothbard when he criticized the current private banking system as "fraudulent". Rothbard takes great effort to historically document that even absent a central bank (ie, during the "free-banking" era of the 19th century), private money creation is dangerous and leads to misallocations of resources and can lead to economic recessions when the misallocations are corrected by the market. However, Roche goes into some "moneyness" nonsense and there I think he errors greatly. He seems to believe that money and other stores of value can be aggregated to form some meaning. There seems to be some obvious problems due to the heterogeneous nature of these assets. For example, sure, bonds can be considered savings, but to use a fruit analogy, the apple is frozen (a bond) and cannot be consumed immediately unlike a normal apple (money). So to aggregate both together and say "let's eat" is silly. Sure there are two apples, but at dinner time, someone isn't going to be able to eat until he thaws the frozen apple (converts it to cash). He uses this error to describe the "non-effects" of QE. The claim is also held by many MMT-advocates that QE isn't money creation because it is only removing savings (US bonds) from bank balance sheets and replacing them with equal value in cash as reserves. I'm no banker, but it seems like the nature of bank balance sheets does matter. Reserves and bonds do not have the same nature just like the apple and the frozen apple. Having more of one and less than the other has an effect on banking behavior. 

This blog just scratches the surface on what's wrong with Roche's blog. I think Roche has valuable insights, but his analysis of Austrian economics is rot with errors.