Sunday, July 20, 2014

How Noah Smith Should Have Criticised Austrian Economics


Noah Smith and Robert Murphy have engaged in a debate on Austrian economics here:
(1) Noah Smith, “Austrian Economists, 9/11 Truthers and Brain Worms,”, July 2, 2014.

(2) Robert P. Murphy, “Noah Smith Boldly Goes Where Thousands of Austrian Critics Have Gone Before,” Mises Canada, July 4th, 2014.

(3) Noah Smith, “Austrianism, Wrong? Inconceivable!,” Noahpinion, July 17, 2014.

(4) Robert P. Murphy, “Continuing My Chats With Noah Smith,” Mises Canada, July 19th, 2014.
Certainly, Noah Smith makes some good points against Austrian economics here and there. Unfortunately, he also misunderstands Austrian theory and makes a number of errors too.

What is a better critique of Austrian economics?

And what, to begin with, is a justifiable and proper economics for modern capitalist economies anyway? I contend it is Post Keynesian economics, and my remarks below follow from Post Keynesian theory.

First, we should recognise that the broad group of economists – both today and in the past – who self-identify as “Austrians” is heterogeneous, not some homogeneous group. We should not expect complete consistency between Austrians, because not all Austrian theories are consistent.

In my view, a useful general, though not definitive or exhaustive, division of modern Austrians would be as follows:
(1) The Anarcho-capitalists
E.g., Murray Rothbard, Hans-Hermann Hoppe and Jörg Guido Hülsmann;

(2) The minimal state/classical liberal Austrians in the tradition of Mises
This variety often supports praxeology and utilitarianism;

(3) Moderate subjectivist Austrians
E.g., Israel Kirzner and Roger Garrison;

(4) Hayek’s economics, with a minimal state, and with an empirical (or Popperian) approach to economic method, in place of praxeology;

(5) Radical subjectivists like Ludwig M. Lachmann (1906–1990), and Austrians influenced by him.
Some Austrians hold theories that are far more objectionable than others (and it is also an open question whether many free bankers really self-identify as Austrians), and not all Austrians agree on all fundamental points: for example, the Austrian school is divided even on the issue of methodology.

Some like Hayek and certain moderate subjectivist Austrians accept a broadly empiricist method for economics and reject Misesian apriorism. Others, following Mises, adopt an apriorist praxeological method.

Before we get to the critique, are there are any points of agreement? Indeed there are.

The Radical subjectivist group of Austrians following Ludwig M. Lachmann is the least objectionable and I suspect Post Keynesians can appreciate Lachmann’s work and even respect certain aspects of it.

It is even possible to point out that both Austrians and Post Keynesians share a number of common beliefs about economics, as follows:
(1) both think money is always non-neutral, whereas neoclassical economists think that money is neutral in either (a) both the long-run and short-run (as in the fantasy world models of the New Classical Chicago school) or (b) at least in the long-run (as in New Keynesian and monetarist theory);

(2) both Post Keynesians and (at least some) Austrians have criticisms of the quantity theory of money; while the Austrians criticise the quantity theory on the basis of Cantillon effects, the Post Keynesian critique is much more radical;

(3) both Post Keynesians and Austrians reject rational expectations and think expectations are subjective;

(4) both Post Keynesians and Austrians stress the role of irreversible time and fundamental uncertainty in economics, and the limitations of probability theory in economic decision making (indeed some Austrians see Keynes’ and Mises’ views on probability as complementary);

(5) both Post Keynesians and Austrians have criticisms of the neoclassical theory of capital, though they part company on exactly what that the critique is.
So what are the serious problems with Austrian theory?

Let us present a case below of some issues point by point:
(1) Misesian apriorist praxeology
Misesian apriorist praxeology as a method for economics is severely flawed.

Mises needed synthetic a priori knowledge and a type of Kantian epistemology to justify his praxeology, but the arguments for synthetic a priori knowledge are unconvincing and must be rejected. Misesian praxeology does not yield universally and necessarily true empirical statements about economic reality.

Furthermore, not even the human action axiom can be known a priori: it is clearly a synthetic a posteriori proposition.

In addition, the very idea that Mises in Human Action succeeded in deducing all his theories by deductive logic is manifestly untrue, and Misesians and Rothbardians have never answered the challenge of George J. Schuller to set out Human Action in a formal symbolic form in which all axioms, premises, and deductions are shown formally and proven.

Even modern Kantians have rejected Mises’ attempt to ground his praxeology on Kant’s epistemology.

There has also arisen amongst modern Austrians a feeble and ignorant belief that Mises was not really using a synthetic a priori epistemology. This is simply untrue, as I have shown here and here, and even if it were true and praxeology were simply analytic a priori, then it would follow logically that praxeology cannot give necessary truth about the real world.
Further Reading
“Limits of the Human Action Axiom,” February 28, 2011.

“Hayek on Mises’ Apriorism,” May 23, 2011.

“What is the Epistemological Status of Praxeology and the Action Axiom?,” July 27, 2013.

“Barrotta’s Kantian Critique of Mises’s Epistemology,” July 28, 2013.

“David Friedman versus Robert Murphy,” August 4, 2013.

“Mises Fails Philosophy of Mathematics 101,” August 30, 2013.

“Bob Murphy All At Sea on Geometry and Economic Epistemology,” August 31, 2013.

“Mises’s Non Sequitur on synthetic a priori Knowledge,” September 2, 2013.

“Hoppe’s Caricature of Empiricism,” September 10, 2013.

“Hoppe on Euclidean Geometry,” September 11, 2013.

“Robert Murphy gets Mises’s Epistemology Wrong,” September 13, 2013.

“Hoppe on Euclidean Geometry, Part 2,” September 14, 2013.

“Mises on Kant and Praxeology,” September 15, 2013.

“Mises was Confused about the Analytic–Synthetic Distinction,” September 15, 2013.

“Schuller’s Challenge to Misesian Apriorists has never been answered,” December 7, 2013.

“Mises versus Ayer on Analytic Propositions and a priori Reasoning,” March 16, 2014.

“David Gordon on Praxeology and the Austrian Method: A Critique,” March 13, 2014.

“Why Mises’s Praxeological Theories are not Necessarily True of the Real World,” March 15, 2014.

“Mises and Empiricism,” April 17, 2014.

“Why Should we reject the Existence of Synthetic a priori Knowledge?,” May 23, 2014.
(2) the Rothbardian interpretation of fractional reserve banking
The Rothbardian interpretation of fractional reserve banking is flawed and ignorant.

The idea that fractional reserve banking is inherently fraudulent or results in two property titles to the same money is false. Demand deposits and indeed all callable loans in the legal systems of Western civilisation are based on the mutuum contract, which is not, and has never been, the same thing as a bailment (or depositum regulare).

The callable mutuum (or loan for consumption) consists of a contract in which a lender transfers ownership of goods/money to a borrower, who then becomes the sole legal owner of that good/money and has the right to dispose of it in whatever way they wish. In return, the lender gets a debt/credit/IOU owed to them by the borrower: the promise to repay the debt on demand. This rules out any situation where the money is jointly owned by two people, as the Rothbardian ignorantly claim.

The anti-fractional reserve banking Austrians also have a horrendously poor and shoddy understanding of history and legal history. Jesús Huerta de Soto utterly misunderstands the historical definitions of mutuum, depositum regulare, and depositum irregulare, and is wrong to claim that the Romans banned fractional reserve banking.

The hostility of Rothbardians to fractional reserve banking via their ignorance of its legal nature arguably makes Rothbardians highly anti-capitalist ideologues, for they wish to ban a non-fraudulent practice which is at the heart of all developed capitalist economies and financial systems.
Further Reading
“Why is the Fractional Reserve Account a Mutuum, not a Bailment?,” December 17, 2011.

“Hoppe on Fractional Reserve Banking: A Critique,” December 11, 2011.

“If Fractional Reserve Banking is Fraudulent, Why isn’t the Insurance Industry Fraud?,” September 29, 2011.

“The Mutuum Contract in Anglo-American Law,” September 30, 2011.

“Rothbard Mangles the Legal History of Fractional Reserve Banking,” October 1, 2011.

“More Historical Evidence on the Mutuum Contract,” October 1, 2011.

“What British Law Says about the Mutuum Contract,” October 2, 2011.

“If Fractional Reserve Banking is Voluntary, Where is the Fraud?,” October 3, 2011.

“Huerta de Soto on the Mutuum Contract: A Critique,” August 11, 2012.

“A Simple Question for Opponents of Fractional Reserve Banking,” August 17, 2012.

“Chapter 1 of Huerta de Soto’s Money, Bank Credit and Economic Cycles: A Critique,” August 31, 2012.

“Huerta de Soto on Justinian’s Digest,” September 1, 2012.

“Huerta de Soto on Banking in Ancient Rome: A Critique,” September 2, 2012.
(3) The Austrian business cycle theory
The Austrian business cycle theory (ABCT) is intellectually bankrupt.

First, the ABCT requires the untenable Wicksellian loanable funds theory. In this theory, the unique Wicksellian natural rate of interest has a crucial coordinating role: if the bank rate falls below the natural rate and monetary inflation continues on a large enough scale, this is supposed to cause an unsustainable lengthening of the structure of production.

But the Wicksellian natural rate cannot even be defined or identified outside of a world with one commodity, as Piero Sraffa long ago pointed out (Sraffa 1932a and 1932b; Rogers 1989: 32 with n. 6; 43). The only viable model in which the Wicksellian interest theory is possible is one which assumes a one commodity world where that single commodity can function both as a capital good or a consumption good, such as the “corn” economy model (Rogers 1989: 32, n. 6).

That is, the natural rate can only be defined in a one commodity world, but not in a world with heterogeneous capital goods (Rogers 1989: 32, 43). The consequence is that only the monetary rate of interest in the loanable funds model is left after the untenable natural rate is cut out, and that the money rate of interest is cut free of the real forces of productivity and thrift (Rogers 1989: 43).

What is especially strange here is that Robert Murphy – one of the popular Austrian bloggers – not only understands Sraffa’s critique but concedes that it is true. Hardly any other Austrians seem even aware of it, or the devastating consequences it has for their business cycle theory.

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.

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”
Murphy’s paper “Multiple Interest Rates and Austrian Business Cycle Theory” makes candid remarks about 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 [1941]) 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.

“Austrian expositions of their trade cycle theory never incorporated the points raised during the Sraffa-Hayek debate. Despite several editions, Mises’ magnum opus (1998 [1949]) 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 [1962]) 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).
Murphy then discusses Lachmann’s (1994: 154) solution to Sraffa’s critique, but finds it wanting:
“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.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 14).
How Murphy can continue to defend the classical Austrian business cycle theory using the Wicksellian natural rate remains a profound mystery, for clearly Sraffa’s critique alone is sufficient to refute it.

But, as it happens, there are also numerous other problems with the ABCT: with the collapse of the natural rate as a viable concept, all that is left of Wicksellian loanable funds theory is the monetary rate of interest, and that – contrary to Austrians – is not explained by time preference, nor does it communicate reliable information about future consumption plans.

The decision to investment – especially in new or more lengthy capital projects – cannot be reduced to some simplistic function of interest rates, and one can only laugh at how crude and stupid the Austrian models underlying the ABCT are, given the extremely important role of expectations and uncertainly in the investment decision.

Above all, the empirical evidence shows us that business people do not really respond to interest rates in the way the ABCT predicts: interest rates do not much affect production decisions in already established firms (Kuehn 2013: 505, citing Tullock 1987 and Akerlof et al. 2000: 505), especially if they have excess capacity.

The finding of Davis, Haltiwanger, and Schuh (1996) “suggests that most job creation (and destruction) happens at large, mature establishments which are presumably primarily making capacity-utilization decisions rather than new capital-expenditure decisions” (Kuehn 2013: 506). That is, capitalist business cycles are driven mainly by changes in capacity utilisation, which in turn are driven by changes in aggregate demand.

Furthermore, the assumptions of Austrian capital theory underlying the ABCT are wrong. The belief that capital goods can be classified into universal, clear-cut orders as removed from the final consumer goods output must be highly doubtful. Many capital goods can simultaneously belong to multiple orders at once. Even though capital goods are heterogeneous, there can also be a significant degree of durability, substitutability, adaptability, and versatility in the capital structure of any real world market economy – and this makes any modern capitalist economy considerably more robust then the Austrian view.

As for the lengthening of the capital structure concept, although this has some validity, the empirical evidence suggests that the capital structure actually “lengthens and contracts as a consequence of the business cycle, rather than as its cause” (Kuehn 2013: 523).
Further Reading
“The Natural Rate of Interest: A Wicksellian Fable,” June 6, 2011.

“Austrian Business Cycle Theory: The Various Versions and a Critique,” June 21, 2011.

“Mises’s “Originary Interest Rate” Theory,” June 21, 2011.

“Robert P. Murphy on the Sraffa-Hayek Debate,” July 19, 2011.

“Robert P. Murphy on the Pure Time Preference Theory of the Interest Rate,” July 13, 2011.

“Hayek’s Natural Rate on Capital Goods, Sraffa and ABCT,” December 27, 2011.

“Hayek’s Trade Cycle Theory, Equilibrium, Knowledge and Expectations,” January 4, 2012

“Some Critical New Work on the Austrian Business Cycle Theory,” October 9, 2012.

“Repapis on Hayek’s Business Cycle Theory,” October 10, 2012.

“Hayek on his Simplified Capital Theory Assumptions in Prices and Production,” October 15, 2012.

“The Natural Rate of Interest in the ABCT: A Definition and Analysis,” February 26, 2013.

“Marshall on Menger’s Orders of Capital Goods,” June 24, 2013.

“Why the Austrian Business Cycle Theory is Wrong (in a Nutshell),” August 3, 2013.

“Daniel Kuehn on the Austrian Business Cycle Theory,” December 5, 2013.
(4) Austrian price theory
The problem with the failed and hysterical Austrian predictions of hyperinflation is that their underlying price theory is obsolete and intellectually bankrupt too, just like their business cycle theory.

First, many Austrians subscribe to a naïve exogenous theory of money supply and the money multiplier myth. In reality, modern money supply is endogenous: the central banks normally just accommodate the demand for high-powered money from banks. To that extent, they are passive, with respect to the quantity of money a capitalist economy creates. Central banks do not directly control the broad quantity of money, and the conventional money multiplier idea is also utterly flawed.

Instead, the primary cause of money supply growth is demand for credit and the creation of credit and “demand deposit money” by banks. But even the demand for credit is not a simple nor straightforward function of interest rates, nor of market clearing of some mythical loanable funds market.

Banks do not lend out your money as in loanable funds theory: the banks use it in their fund of reserves for clearing their obligations to depositors/creditors, other banks and financial institutions, and central banks, and simply create “demand deposit money” whenever they grant credit. Loans create new “demand deposits,” and such “demand deposits” constitute new broad money. But of course such new loans also require that there be demand for credit, and that is determined by many factors, not just interest rates.

Hence, when central banks in the UK and the US engaged in their unprecedented experiments in quantitative easing, they were able to increase the quantity of high-powered money and reserves to a great extent, but they could not induce a corresponding demand for credit by these actions, nor cause the banks to vastly increase lending and spending throughout the economy.

But even if there had been a great increase in spending it is still unlikely that this would have led to uncontrollable inflation, and here we must look at how flexible prices are in the real world.

The fact that the satisfaction or utility that humans derive from consuming goods is indeed subjective, and that there is a great deal of empirical evidence that subjective utility diminishes as a person consumes each additional unit of the same good does not prove that prices are therefore naturally or normally set in a flexible manner and are highly responsive to demand, by mutual haggling or in auction-like markets where the prices have a tendency to move to market clearing levels.

Most prices are not set in this manner, but by a very different method.

Virtually all Austrians, apart from a few like Lachmann (1986: 134; 1994: 165–166) and Reisman (1996: 167–169, 200–201, 414–417), have utterly failed to understand the reality and nature of administered prices/mark-up prices, and how the prevalence of such prices is utterly devastating to their economic theories.

Most prices are set by sellers or producers on the basis of their total average unit costs plus a profit mark-up at some estimated or projected sales or production quantity, and are, generally speaking, not responsive to demand changes. Demand-side inflation is consequently an overrated source of inflation in the modern world. The more important type of inflation is supply-side inflation caused by changes in firms’ total unit costs.

At this point, the empirical evidence is in, and it shows us that most prices in modern developed market economies are administered prices/mark-up prices.

For example, Govindarajan and Anthony (1986) and Shim and Sudit (1995) are two marketing surveys that found that from the 1980s to the 1990s mark-up pricing accounted for roughly 70% to 85% of US industrial prices.

Blinder et al. (1998: 200–201) found that 56.8% of the firms they surveyed said that the idea that prices and price changes depend mainly on costs of production ranked as “very important” (38.8%) or moderately important (18%).

The wide-ranging survey of Fabiani et al. (2006 and 2007) on prices in the Eurozone from many central bank studies finds that the average for mark-up pricing throughout the Eurozone is 54% – a majority of firm prices.

In industrial goods markets in Germany, the largest economy in Europe, a strikingly high 73% of firms have administered prices (Fabiani et al. 2006: 18, Table 4).

A survey of Canadian firms found that an impressive 67.1% of firms surveyed attributed price inflexibility to “cost-based pricing” – that is, to mark-up pricing (Amirault, Kwan, and Wilkinson 2004: 21).

Have Austrians come to grips with this important reality of real world price setting? They have not, and the sole exception, as far as I can see, was Ludwig Lachmann.

Lachmann understood the extent and significance of mark-up pricing and said the following:
“Hence, while Marshall’s was a world of flexible prices, even though not of ‘perfect competition,’ ours is a ‘fixprice world’ with prices set on a ‘cost plus’ basis and wage rates as ultimate price determinants. …. Hence we have to look for another method of dynamic analysis. To find it we must move nearer to Keynes and his successors who are here given credit for having understood, earlier than others, that a fixprice world requires a fixprice method of analysis.” (Lachmann 1977: 238–239).
(5) Misesian economic coordination and prices
The flexible price and wage system is the fundamental equilibrating mechanism in Misesian economics:
“Mises conceives the market process as coordinative, ‘the essence of coordination of all elements of supply and demand.’ This means that the structure of realized (disequilibrium) prices, which continually emerges in the course of the market process and whose elements are employed for monetary calculation, performs the indispensable function of clearing all markets and, in the process, coordinating the productive employments and combinations of all resources with one another and with the anticipated preferences of consumers.” (Salerno 1993: 124).
But following from (4), the Austrian view that modern market economies have some natural or normal tendency to supply and demand equilibrium via flexible prices is untrue.

In reality, supply and demand in most markets is not equated by price flexibility, but by direct changes to production and output: increases in aggregate demand cause greater production and employment, and falls in aggregate demand cause reduced production and employment. This supports the Keynesian view of modern economies, not the Austrian one.

A detailed discussion of problems for Austrian theory caused by the reality of administered prices is given here.
Further Reading
“Salerno on Mises’s View of Coordination in Market Economies,” March 23, 2013.

“Hayek on the ‘Use of Knowledge in Society,’” March 30, 2013.

“Misesian Economic Calculation and Coordination in Market Economies: An Overview and Critique,” May 11, 2013.

“Kaldor on Economics without Equilibrium,” March 9, 2013.

“Administered Prices Discredit the Austrian Economic Theories of Mises,” December 10, 2013.
(6) The definition of inflation
This is, in the grand scheme of things, really a minor point, but I raise it because it is relevant to the original debate.

The Austrians have an obsession with the definition of the word “inflation.” They claim that the original and legitimate definition of “inflation” is as an increase in the money supply, instead of (as people normally use it) a general increase in prices.

In reality, there is precious little evidence for this view. The word “inflation” began to be used in an economic sense from the early 19th century: but it was nearly always qualified by additional words such as “inflation of the currency,” “inflation in (the) currency,” “inflation of credit,” “inflation of prices” or “inflation in prices.”

It is extremely difficult to see how either sense was the “original” or formally correct usage.

In fact, the expressions “inflated prices” and “inflated price” seem to appear at the same time, so that the word “inflate” and its derived forms were clearly connected with prices from an early date.

There are explicit examples of this usage in the 1821 English translation of Jean Baptiste Say’s A Treatise on Political Economy:
“We have hitherto regarded the inflated price of grain as the only evil to be apprehended. But England, in 1815, was alarmed by a prospect of an opposite evil; viz, that its price would be reduced too low, by the influx of foreign grain.”
Say, Jean Baptiste. 1821. A Treatise on Political Economy; or, The Production, Distribution, and Consumption of Wealth (vol. 1; trans. by C. R. Prinsep from 4th French edn.). Longman, Hurst, Rees, Orme, and Brown, London. p. 296.

“The experience of English commerce has, however, proved, that a casual inflation of the price of domestic, and depression of that of external products, may be the basis of permanent commerce.”
Say, Jean Baptiste. 1821. A Treatise on Political Economy; or, The Production, Distribution, and Consumption of Wealth (vol. 1; trans. by C. R. Prinsep from 4th French edn.). Longman, Hurst, Rees, Orme, and Brown, London. p. 176.
If we turn to a major 19th-century economist like William Stanley Jevons, we find that he used “inflation” in both senses in his writings too:
“While the elasticity of credit, then, may certainly, as it seems, give prices a more free flight, the inflation of credit must be checked by the well defined boundary of available capital, … .”
Jevons, William Stanley. 1863. A Serious Fall in the Value of Gold Ascertained, and its Social Effects Set Forth. E. Stanford, London. p. 13.

“A revulsion occasioned by a failure of the national capital must, cause, not only a collapse of credit, and of any inflation of prices due to credit;”
Jevons, William Stanley. 1863. A Serious Fall in the Value of Gold Ascertained, and its Social Effects Set Forth. E. Stanford, London. p. 14.
Admittedly, this was also one of the points where Noah Smith was wrong.

Smith asserted:
“The Austrians’ next defense [after 2011] was to redefine reality. Inflation doesn’t mean a rise in prices, they said -- it means an increase in the monetary base. QE wasn’t causing inflation, it was inflation itself.”
Of course, the Austrians did not turn to this definition in the early 2010s: they have been peddling this pedantry for decades, but, as we have seen, the evidence does not support them.
Further Reading
“Austrians and the Definition of ‘Inflation’ Again,” July 8, 2014.

“Austrians and the Definition of ‘Inflation,’” August 8, 2013.
Finally, the above is hardly an exhaustive list, and the indeed Austrian theory shares many errors with mainstream neoclassical theory, such as the following:
(1) belief in a real world tendency to some kind of equilibrium state (in Austrian theory, this tends to be Mises’ final state of rest), via flexible wages and prices and competition supposedly driving prices towards marginal cost, and profits towards zero;

(2) the belief that, if only prices and wages were perfectly flexible, then economies would adjust to full employment equilibrium.

(3) the gross substitution axiom;

(4) the law of demand as a universal law;

(5) the law of diminishing marginal utility as a universal law;

(6) the law of diminishing marginal productivity as a significant limit on real world firms;

(7) the belief that firms equate price with marginal cost or move price towards marginal cost, and the associated marginalist explanation of why and how much firms produce, and

(8) the belief that involuntary unemployment is fundamentally caused by inflexible wages and that the wage is itself determined by marginal product of labour.
Akerlof, G., Dickens, W. and G. Perry. 2000. “Near-Rational Wage and Price Setting and the Long-Run Phillips Curve,” Brookings Papers on Economic Activity 1: 1–44.

Amirault, D., Kwan, C. and G. Wilkinson. 2004. “A Survey of the Price-Setting Behaviour of Canadian Companies,” Bank of Canada Review 2004/2005: 29–40.

Blinder, A. S. et al. (eds.). 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage Foundation, New York.

Davis, S. J., Haltiwanger, J. C. and S. Schuh. 1996. Job Creation and Destruction. MIT Press, Cambridge, Mass.

Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Fabiani, Silvia, Suzanne Loupias, Claire, Monteiro Martins, Fernando Manuel and Roberto Sabbatini. 2007. Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York.

Govindarajan, V. and R. Anthony. 1986. “How Firms use Cost Data in Price Decisions,” Management Accounting 65: 30–34.

Jevons, William Stanley. 1863. A Serious Fall in the Value of Gold Ascertained, and its Social Effects Set Forth. E. Stanford, London.

Kuehn, Daniel. 2013. “Hayek’s Business-Cycle Theory: Half Right,” Critical Review 25.3–4: 497–529.

Lachmann, Ludwig M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. Walter E. Grinder). Sheed Andrews and McMeel, Kansas City.

Lachmann, Ludwig M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford. 134.

Lachmann, Ludwig M. 1994. “The Salvage of Ideas: Problems of the Revival of Austrian Economic Thought,” in D. Lavoie (ed.), Expectations and the Meaning of Institutions: Essays in Economics. Routledge, London. 159–178.

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.”

Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory. Cambridge University Press, Cambridge.

Salerno, Joseph T. 1993. “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6.2: 113–146.

Say, Jean Baptiste. 1821. A Treatise on Political Economy; or, The Production, Distribution, and Consumption of Wealth (vol. 1; trans. by C. R. Prinsep from 4th French edn.). Longman, Hurst, Rees, Orme, and Brown, London.

Shim, Eunsup, and Ephraim Sudit. 1995. “How Manufacturers Price Products,” Management Accounting 76.8: 37–39.

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251

Tullock, Gordon. 1987. “Why the Austrians Are Wrong about Depressions,” Review of Austrian Economics 2: 73–78.


  1. Do you know that you can make the text box wider if you want to?

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  2. LK,

    While you've pretty exhaustively debunked most vulgar Austrian myths, there's one I don't remember a post on--the claim that "all fiat currencies eventually undergo hyperinflation; there are no historical exceptions."

    I could think of a number of ways to eviscerate such a thesis, but I also think you could probably do a more extensive and nuanced job than I. Regardless, I see internet Austrian cranks bandy it about constantly to divert attention from their woefully inaccurate inflation predictions.

    1. Well, all nations on earth have been using fiat currencies since about the 1930s/1940s, and hyperinflation has only happened to small percentage of these nations.

      Even if in the past there were numerous examples of fiat currencies ending in hyperinflation, it does not follow that the same thing will happen in the future to all nations using fiat currencies today.

      This is very much like someone in 1902 saying:

      "all attempts at powered, heavier-than-air flight have ended in failure -- therefore such a thing can never be done!"

      But then the Wright brothers' famous first flight happened the next year in 1903 -- and the age of power flight began, totally destroying that argument.

      It is so obviously a fallacious argument and the libertarians are making the same type of flawed argument here.

    2. The best refutation to these kinds of pronouncements is a counter example. I suggest that the pre-euro Franc is a currency which never hyperinflated and is now replaced so it won't ever do so.

    3. All great points--usually the crazy libertarians purveying this line of reasoning use it as validation for the even more ridiculous "All governments fail eventually" argument, which I usually attack on the basis that it's a useless tautology, akin to saying "All living people have died, except for those currently living"--but this is but one hole in an argument sporting more of them than a slice of swiss-cheese.

      Thanks again for your contributions here to the war against the Austrian trolls. Fortunately what advantages they have in numbers cannot compensate for what they lack in brains.

    4. The goldbugs' basic accusation contending that all fiat currencies 'collapse/fail/hyperinflate' is exactly the opposite of the truth. In fact, all schemes to "back" currency with metals or commodities have failed... that is why there are no 'backed' currencies left on earth!

  3. Not actual profit, just psychic.

  4. This is a very solid post, though I think you focus too much on Rothbardian Austrians at the expense of the more mainstream ones, who are undoubtedly the majority.

    The one area that I think you may not be fairly representing is ABCT, in particular the natural rate theory that underlies it.

    Have you seen this ?

    The paper shows how Keynes contributed to the multiple rates debate, and how Hayek's views (on multiple rates at least) are more defensible than you give them credit for.

  5. One thing I never understood about the Austrian use of inflation to mean money supply is simply, so what? If there was a simple monetarist relationship between prices and money supply then "monetary" inflation does affect people, but that's because it is also price inflation and so there is no reason to make a distinction. Of course in reality there is no simple relationship between price and money "supply", which means you can point to a "monetary" inflation separate from price inflation. But in this case why should anybody care? If prices aren't changing then it doesn't affect how much people can buy with a certain income. Money supply becomes a pointless aggregate that doesn't really mean a lot. So what if there is monetary "inflation"? I could define inflation to mean the change in surface temperature of Mars.

    1. Yes, their obsession with the word "inflation" is just another aspect of bankrupt economics.

  6. tally sticks and Greenbacks, also did not go hyper. I'm sure there are many others

  7. Most of the critiques would also affect Noah Smith's own New Keynesian/neo-Keynesian framework. So don't expect him to pick up on them any time soon.

    1. That's the problem when Post Keynesians take down Austrian economics -- neoclassical economics collapses as well!

    2. My comment on Smith's blog:

      Very amusing. Of course the elephant in the room remains: most neo-Keynesian and New Keynesian textbooks lay out a money multiplier theory of the effect of an increase/decrease in bank reserves. This would imply that a rise in the monetary base would lead to "multiplying up" of other monetary aggregates. This, in turn, would lead to a rise in either output or inflation (or some combination of both ala perhaps the DAD-SAS model or a standard AS-AD model both of which are used for didactic purposes in this regard).

      But none of this happened! The monetary base was never "multiplied up". Now, the New Keynesian/neo-Keynesian might say "Oh, we're in a liquidity trap therefore the demand for base money is infinitely elastic". But then we would expect that asset markets would be trading low and interest rates across the private bond market would be high. After all, if a "liquidity trap" is indeed defined as the demand for money being infinitely elastic then we would expect "hoarding" to be absolute and we would expect none of this money to flow into various asset markets.

      Feeling dizzy yet? Yeah, you see when you start criticising Austrian theory the worms start to come out of the woodwork on marginalist theory more generally. You guys are way closer to Murphy than you think -- even if you find his ideas about hyperinflation and voices talking to him in his head [] a little zany as, by all rights, you should.

    3. Great comment. Am still laughing over the last paragraph!

  8. LK,
    Imagine I am studying ideal gases. I define "inflation" as a change in volume not offset by a reciprocal change in pressure, such that the product PV increases.
    This is the Mises def'n. Arguing, as many do at Murphy's, that a change in pressure is inflation is easily seen to be wrong with this definition.

    1. I have to confess that my knowledge is physics is not good enough to completely grasp this analogy, but I think I get the general point.

      Mises’ statement in "The Free Market and Its Enemies" (1952 [2004]), p. 44

      “Inflation is an increase in the quantity of money without a corresponding increase in the demand for money, i.e., for cash holdings.”
      The vulgar Austrians are ignoring that proviso: "without a corresponding increase in the demand for money". Right?

    2. Exactly. But that proviso means you can only have inflation when you have a price change. If the money supply changes but prices do not then you say the demand for money rose, and if prices rise you say you have inflation. So operationally inflation means some function of price changes.
      Typical Murphyite muddying of the waters, insisting on talking about and treating as fundamental unobservable things.
      We can observe money and prices ( more or less), so let's talk in terms of those

  9. This is a great war crest. Just my 2 cents.

    1. Kant was *the* major philosopher of the enlightenment and Mises was a clown with no serious understanding of philosophy. Any association between the two is merely an austrian wet dream and frankly offensive to anyone interested in philosophy.

    2. Mises thought Rand's "philosophy" was "telling it like it is". This reveals beyond the shadow of a doubt that he wouldn't comprehend serious epistemology if it hit him over the head with a frying pan filled with boiling oil.

    3. According to Mises: "Aprioristic reasoning is purely conceptual and deductive. It cannot produce anything else but tautologies and analytic judgments. All its implications are logically derived from the premises and were already contained in them.". None of this makes any sense epistemologically for reasons I'm too bored to get into. One point to start is that reasonings can not be synthetic or analytic in the first place, as they are reasonings, not judgments, and in all deductive reasonings the conclusion is merely transfused with the content of its premises. This doesn't make deductive reasonings tautological. If that was the case everything, even induction, could be said to be tautological as this is the function of logical inference. Anything else would be a leap of faith. Deductive reasoning isn't even relevant with a priorism. You can have empirical deductive reasonings (All dinosaurs on earth have died -a posteriori judgement- , T-rexes are dinosaurs -a posteriori judgment-, all T-rexes have died). I have no idea if at some point he also argued he was creating synthetic judgments. I can not see how he could view the human action axiom as analytic, but it's possible that he didn't even get what exactly was supposed to be tautological or that he just jumped back and forth between these ideas that he didn't comprehend in order to avoid being disproven.

    4. Kant was not an idealist as people like to assume. Kant explicitly stated he was mad that they thought so because he used the term transcendental ideality to describe the way we process phenomenal contents through a priori rational categories and concepts in the prolegomena to any future metaphysics. Kant believed most knowledge was not pure, but empirical, simply processed through rational categories. Pure reason is auxiliary in his epistemology (while synthetic a priorisms were pretty much reserved for practical reason, his cognitivist system of morality). This understanding is pretty much accepted in contemporary epistemology. But in short, he was no petty idealist that thought pure reason could grant us any concrete knowledge about anything other than oughts. The idea that you could use synthetic a priorisms to reach conclusions about economics is like trying to decipher the color of a wall in paris through pure reason. It's not possible and if it were the conclusions would *always* be validated by reality. Their validation would be presupposed by every rational subject before he even sensed reality. We would all filter reality through the filter of those statements.

    5. Popperian critical rationalism is hypothetico-deductivist. It's also based on a priorisms. Key word "Crirical". The conclusions (and premises) need to be falsifiable simply because the theories -though constructed abstracly- are aiming to explain empirical phenomena. Mises' epistemology is old-school rationalist. Descartes' style rationalist, if descartes was an inbred.

    6. Positivism failled hard on literally every front. falsificationism is post-positivist and hypothetico-deductivist and scoffs at inductivism as the garbage that it is.

  10. 7. Kant didn't believe determinist causation is a truth about the universe known a priori. He believed that determinist causation is a concept through which we filter experience. The phenomenal content of the universe would be chaotic for Kant. We simply experience it in an orderly array because we filter it through specific categories of pure reason like time, space, distance, causation etc. Even the positivists agreed this far. This is very important, you are trying to filter Kant through Mises' squibblings. Kant did not believe you could reach conclusions about empirical reality a priori. He thought you could reach conclusions about pure reason and its concepts (and by extension about aesthetics and practical reason/morality) a priori. This is very important. Kant did not believe synthetic a priori judgments were about phenomena, but about the categories of thought. For example you could use the rules of pure reason and the concepts of pure reason to create a system of intersubjective morals, a series of oughts that all rational subjects could concede (in his own terms, duties that reason autonomously imposes on itself). In short pure reason has these functions, it processes and arranges the phenomenal images we receive from our senses (for example turning what we see upright again, though our eyes receive the image upside down) it can't tell us what they are a priori for obvious reasons that Mises did not want to understand. It also makes value judgments and wills actions and in those processes imposes maxims on itself.

    8. You therefore likely don't really reject synthetic a priorisms (unless you are commited to a post-modernist approach, that all oughts are subjective or even that all morality is just feelz -expressivism, a debunked notion- and that all value judgments are either radically subjective or meaningless gibberish).

    9. This is irrelevant with the fact that mises is not actually creating synthetic a priorisms in the first place, and that even attempting to do so would be absolutely nonsensical, see the wall in paris example. This is very evident in lulzworthy garbage like the idea that "synthetic a priori statements are statements you need to affirm in order to criticise", closer to the fallacy of the stolen concept that Rand also abused. This has fuck all to do with synthetic a priorisms. The statement "humans act purposively" is empirical. They simply have no clue what they are talking about and think the fact the term has a conceptual width (all the concepts that can be banded under "Act") and not just a depth (the definition of "Act") somehow makes it a priori. In that case "Pluto is not a "Planet"" is also an a priori judgment considering the term Planet also has a width that encompasses many different objects.

  11. 10. In another post you metioned Lorenz. Lorenz also has no idea what he is talking about. The thing-in-itself is not knowable period. In order to know anything we need to process sense-date through our reason, what we end up with is that rational reconstruction of the sense-perception of the thing in itself. Therefore we don't know the thing in itself. We know what our senses and reason cooperate to show us. If either is problematic we don't get the complete picture. Even moreso than that, it's not that we don't get the full picture. There is no right way to approach the thing-in-itself, it will necessarilly be colored by the instruments through which you grasp it. This has nothing to do with how we ended up with that specific instrument of Reason. Obviously we adapted for it. But this betrays a misunderstanding of the apriori/a posteriori distinction. It has no relevance with how the cognitive aparatus was developed. It's there as it is and it shapes our perception. This is the innate subjective transcendental ideality of our perception. Our reason bridges the gap between the world and the individual. The distinction is relevant with whether something is knowable through experience or through reason. For example math is not empirical, it's a priori. This has no relevance with the fact the instrument of reason through which an abstraction like math is formed is itself developed through material circumstances. Kant, was not, a berkeley-tier idealist. The point is that cognitive categories exist before/irregardless of experience, you don't get nurtured into developing a sense of time or space. You just have it. This can go even further, for example cognitivist linguists like Chomsky borrow heavilly from Kant and argue that even the structure of language is pretty much based on a priori cognitive categories.

    >According to Lorenz, and contrary to Kant, the thing in itself (Das Ding an Sich) is knowable through the categories of the knower, not the characteristics of the thing in itself

    Literally wat. That's exactly what Kant is saying. The thing in itself is approached through the categories of the knower. Literally what he called his copernican revolution.

  12. 11. In another post you mentioned quine. Quine was not a positivist. He was against the strict analytic/synthetic distinction in whole. His point was that we can not cleanly distinguish between our analytic and our synthetic statements, with analytic statements sometimes having synthetic components that form a web of beliefs that all influence one another. His major work *was* two dogmas of empiricism, after all. So we have two paralel lines. We say that paralel lines never meet. This is an a priori analytic truth. But it presupposes that the space the lines are moving through is "normal", which is an a posteriori synthetic judgment. Therefore we can actually falsify the analytic truth. After all if the lines are passing through the center of gravity of a black hole, then the space they are moving through is distorted and thus they get distorted as well. They are still parallel but they meet twice. The problem here isn't that the tautology has been disproven by an observation, it's that the tautology was presupposing specific empirical conditions to make sense in that way. Hence the a priori/a posteriori synthetic/analytic distinctions are useful but not absolutely rigid because they form a united web of beliefs parts of which may be tarnished effecting all knowledge that is contingent on them, in effect changing the entire structure of our knowledge

    If you need to take something from Quine then that's not that all judgments are a posteriori (Quine himself would vehemently disagree), but that we can't really isolate any judgment so that it can stand or fall on its own. It may be an analytic, tautological truth, and it may still be contingent on an a posteriori synthetic component, and that component may rely on an a priori synthetic concept and that concept may rely on a tautology that stands or falls based on another observation.

    That's all. Pls go on.