Neoclassical:In essence, you are agreeing that market participants are "thin skulled," since you actually described the "greater fool theory"
No, I am not describing the greater fool theory. I am describing the distortion to the structure of production that is introduced by the central bank. This also creates the "cluster of entrepreneurial errors", and a widespread boom and bust across all industries, all geographic locations, the entire world even, at the same time.
It has nothing to do with selling to the "greater fool". My description was imprecise as I was trying to use a simple example.
The entrepreneurs during the artificial credit expansion are not stupid. They are not foolish. The folks they are selling to are not foolish. Nobody is foolish. Whether or not someone is foolish is not the crux of the theory.
ABCT is in direct contrast to normal "fluctuations" that occur due to specific entrepreneurial error, or specific industries, or regions affected by bumper crops or draught, for example. The market automatically adjusts to those types of fluctuations if it is left alone. Fluctuations like this are part of the market "process".
When I read critiques of ABCT, I almost always sense that the critic does not understand (or ignores / refutes) capital theory and the structure of production.
"The market is a process." - Ludwig von Mises, as related by Israel Kirzner. "Capital formation is a beautiful thing" - Chloe732.
I think the criticism is that even if Austrian business cycle was mainstream, or widely accepted as true, the fact that entrepreneurs still fall prey to artificial interest rates makes them "stupid" or "irrational". This criticism, however, does not hold water when you consider the following arguments,
To me, the criticism of Austrian theory that entrepreneurs should begin to "see it coming" is the most elementary. If that is what economists are grasping onto, then it means they have no real criticism to offer.
No one has answered why bad investments would necessarily be made. Why, according to the Austrians, does "speculative" irrationality increase? Why don't entrepreneurs have the same chance of profit-or-loss?
How is the entrepreneur to distinguish how much savings is based on prior production and how much from monetary inflation when the central banks perpetually corrupt the interest rates via OMO etc.? It's like someone shifting the magnetic poles of the earth around all the time, then blaming a captain for being a poor navigator because their compass isn't taking them where they want to go... in spite of their navigational skills, when it's not their fault at all. I'm honestly curious why Caplan and Cowen are too obtuse to understand this. It boggles the mind how neoclassicals will understand price-control theory generally but not the ABCT.
I remember reading Mises saying that, yes it is theoretically possible that eventually people will wise up.
Let's assume that is so. What measure will entrepreneurs use to gauge the level of productive savings in the economy barring the interest rate? If the answer is "none" (and it probably is), the issue (that others have described before me) is that their competitors still will avail themselves of artificial (?) credit putting them at a competitive disadvantage (if FRB were not propped up by a central bank it'd be too unstable to allow for this.) Entrepreneurs can hardly divine the interest rate because they've -no- idea where it should be due to repeated governmental interventions in the economy not allowing corrections to take place. The weather may be more complicated than the Fed's actions, and more unpredictable, but actually knowing where the interest rate would be absent CB interventions is far more difficult.
Freedom of markets is positively correlated with the degree of evolution in any society...
Jonathan M. F. Catalán:What the "natural" rate of interest is unknown, as society's time preference cannot be calculated and expressed as a number. As such, even if entrepreneurs considered that the rate of interest is artificially lower then it should be they have no idea by how much.
Yes, they do! Quoting Bryan Caplan, But why couldn't they just use the credit market's long-term interest rates for forecasting profitability instead of stupidly looking at current short-term rates?
To quote an article by Peter Robinson, As Fed chairman, [Greenspan] had only lowered short-term interest rates, he argued in the Wall Street Journal, not the long-term rates on which mortgage prices are based. "No one, to my knowledge," Greenspan huffed, "employs overnight interest rates--such as the Fed Funds rate--to determine the capitalization rate of real estate."
Commenting on that idea, Bryan Caplan states, The government cut interest rates, and then... banks started offering loans to people who wouldn't be able to pay them back - and borrowers accepted. . . . Unfortunately, for [the ABCT] story to work, we also have to admit that business and consumers are so clueless that they're habitually on the edge of disaster.
There's no hiding the fact that LvMI scholars repeatedly, in books and online, blame human irrationality during "speculative booms." Giving them more credit should not lead to "malinvestments," just more investments that can either lead to profit or loss. This isn't a price control per se--if there were a floor, there would be excess supply; if there were a ceiling, there would be a shortage.
Essentially, Austrians claim that investors are too stupid to use credit wisely.
chloe732:The entrepreneurs during the artificial credit expansion are not stupid. They are not foolish. The folks they are selling to are not foolish. Nobody is foolish. Whether or not someone is foolish is not the crux of the theory.
According to the ABCT, they are! Why would so many investors make decisions that lead to economic disaster and liquidation?
Smiling Dave:Not exactly. This version is very dangerous [besides being incorrect]. It is saying "People are fools. Any glancing blow can set them off. This time it was the govt, next time it will be some thing else. Obviously, the best thing is to take the money away from the common man, for his own good of course, and let wise benevolent govt planners run the show for him."
I agree! That's one reason I hate the Austrian Business Cycle Theory! I believe it states that booms are caused by human irrationality ("speculative" booms) which, clearly, criticizes the ability of investors to manage their own funds wisely.
Smiling Dave:Sure, people are full of irrational speculative excess, all the time, 24/7. BUT THEY DONT HAVE MONEY. What normally happens in a normal economy is that the guys who don't know any better and also have money lose it very quickly. The combination of a fool and his money is pretty rare, and short lived. There are not enough fools with money to be able to go out there and create a bubble. I mean, we are talking about big bucks here, enough to disrupt a whole country and bring it to recession.
Why would credit immediately lead to malinvestments? Why not simply more investments, with a typical proportion of profit and loss?
Also, why does bubble form in a particular sector (e.g., housing)?
"I'm not a fan of Murray Rothbard." -- David D. Friedman
Smiling Dave, strong rebuttal on my "weather" example.
Smiling Dave: Neoclassical:Do all Austrians simply disbelieve in rational expectations (http://en.wikipedia.org/wiki/Rational_expectations)? Oh, absolutely. It's a ridiculous myth, rational expectations. You people are crazy! If you want to abolish Social Security because you predict that people will privately save for their retirement, then you believe in rational expectations! "I'm not a fan of Murray Rothbard." -- David D. Friedman | Post Points: 20
Neoclassical:Do all Austrians simply disbelieve in rational expectations (http://en.wikipedia.org/wiki/Rational_expectations)?
Neoclassical: There's no hiding the fact that LvMI scholars repeatedly, in books and online, blame human irrationality during "speculative booms." Giving them more credit should not lead to "malinvestments," just more investments that can either lead to profit or loss. This isn't a price control per se--if there were a floor, there would be excess supply; if there were a ceiling, there would be a shortage. Essentially, Austrians claim that investors are too stupid to use credit wisely.
Now should investors be able to predic this? Yes. But even if they did, they can still hold out the hopes that their investments won't fail because cheap credit allows them to bid away resources from other ventures. Moreover, the greenspan put and other unspoken authoritarian gaurantees make it rational to overinvest in certain markets.
Rush Limbaugh blames people for being stupid and taking out loans. Austrians claim everyone basically played the game rationally, its just a lousy game.
Nope.
By determining short-term interest rates, a central bank exerts a strong influence on longer-term interest rates (such as, for instance, 10-year bond yields). The expectation theory of the term structure of interest rates explains why this is the case.[1] In its simplest version it says that a long-term interest rate such as, for instance, the 10-year bond yield, is a weighted average of short-termed interest rates expected over the maturity of the credit contract.
By determining short-term interest rates, a central bank exerts a strong influence on longer-term interest rates (such as, for instance, 10-year bond yields). The expectation theory of the term structure of interest rates explains why this is the case.[1]
In its simplest version it says that a long-term interest rate such as, for instance, the 10-year bond yield, is a weighted average of short-termed interest rates expected over the maturity of the credit contract.
Then to this:
Spend less time hating it and more trying to understand it. It has nothing to do with "irrationality" but more to do with tampering with a price signal, i.e. interest rates. That said, Austrianism does use a much weaker form of rationality than mainstream economists. That is a strength of it because it shows it requires much less on part of market participants for its theories to prove correct than the much stronger form of rationality neoclassicals posit.
What does is mean to act "rationally"?
When speaking in terms of Austrian lingo, there is a difference between "rational" and "perfect". In the Austrian framework, all actions are "rational" but that doesn't mean perfect foresight.
Sieben: Neoclassical:There's no hiding the fact that LvMI scholars repeatedly, in books and online, blame human irrationality during "speculative booms." Giving them more credit should not lead to "malinvestments," just more investments that can either lead to profit or loss. This isn't a price control per se--if there were a floor, there would be excess supply; if there were a ceiling, there would be a shortage. Essentially, Austrians claim that investors are too stupid to use credit wisely.Not at all.
Neoclassical:There's no hiding the fact that LvMI scholars repeatedly, in books and online, blame human irrationality during "speculative booms." Giving them more credit should not lead to "malinvestments," just more investments that can either lead to profit or loss. This isn't a price control per se--if there were a floor, there would be excess supply; if there were a ceiling, there would be a shortage. Essentially, Austrians claim that investors are too stupid to use credit wisely.
Like I said, there's no hiding this. I'm not sure why several of you are doing so. Let me quote some contemporary, orthodox, respected Austrian economists.
Robert P. Murphy, [M]arkets are capable of periods of mass delusion as it were, in which asset prices get pushed far above any "rational" level justified by the underlying fundamentals.
Jesus Huerta de Soto, Widespread discoordination in the economic system results: the financial bubble ("irrational exuberance") exerts a harmful effect on the real economy, and sooner or later the process reverses in the form of an economic recession, which marks the beginning of the painful and necessary readjustment. This readjustment invariably requires the reconversion of the entire real productive structure, which inflation has distorted.
Doug French, People seem to do the craziest things when it comes to money. Whether it's chasing stock-market bubbles or paying good money after bad on a home that's hopelessly underwater, the idea of individuals acting as homo economicus seems far-fetched. Only in the ivory-tower world of rational-expectations theory does one find perfectly rational humans making judgments using all available information to satisfy their subjective ends.
Could you tell me which of these quotes actually blames the business cycle on irrationality?
"Mass delusion" = result of thwarted price signals.
"Irrational exuberance" = a borrowed phrase, in scare quotes no less.
"Seem" = self-explanatory. The last does repudiate the neoclassical view of rational expectations but Austrians do not take this as necessary to posit rational action.
Giant_Joe:What does is mean to act "rationally"?
I know that Austrians believe it is simply means-end analysis, making any purposive being "rational."
http://en.wikipedia.org/wiki/Rational_choice_theory
In essence, if we presume humans are maximizing their utility--attempting to increase their satisfaction as Mises might put it--then why, ever, would they invest in a "speculative boom" that would lead to loss and liquidation?
It's very hard to imagine someone purposefully walking off a cliff. Not impossible, of course, but the assumption holds enough to be used for predictions.
None of them are saying that people are too stupid to use credit wisely. As has been said, it's not that the people are stupid, it's that the game has been rigged. People tend to make the best informed decisions they can, given what they know. If the interst rate is 2%, then they will act on that fact. They don't know what the interest rate "shold be" and they don't know when it will get there. It would be like saying "I know what the price of X should be on the market." People can't just know this, so they can't act on this.
Damn you Jon! I was going to post the Polleit daily! curses!
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
Jon Irenicus: Could you tell me which of these quotes actually blames the business cycle on irrationality?
All of them!
Jon Irenicus:"Mass delusion" = result of thwarted price signals.
Rational expectations predicts that market participants will wise up at some point; why don't you? For instance, if inflation is rising, you don't believe workers will include such knowledge into their contract negotiations?
Jon Irenicus:"Irrational exuberance" = a borrowed phrase, in scare quotes no less.
This is a quoted phrase, borrowed for a purpose. It was used unironically and uncritically.
Jon Irenicus:"Seem" = self-explanatory. The last does repudiate the neoclassical view of rational expectations but Austrians do not take this as necessary to posit rational action.
He posits that humans employ irrational means to achieve the ends they seek. If this is correct, faith in the free market collapses!
Once again, our commitment to the self-correction of the market also applies here; we adjust to government interventions to short-term interest rates!
you overlook the time it takes for errors to be revealed, i.e. you do not even mentino the speed at whcih error correction can occur.
you overlook the fact that the government intervenes dynamically, in large part directly with the intention of 're-erroring' entrepeneurs when they begin to correct for errors in ways that the government doesn't like.
thats a lot of overlooking
And I asked how? What will they use instead of the interest rate, the price of credit? They could stop borrowing altogether, but how would they then compete with competitors willing to
It seemed more like an Austrian explanation of the posited phenomenon.
If he does, then he does not do so as an Austrian economist... but he doesn't. He used "seems".
How, when the government constantly distorts the interest rate? You seem to think that entrepreneurs are miracle-workers who can circumvent the government's mucking about.
Neoclassical: Jon Irenicus: Could you tell me which of these quotes actually blames the business cycle on irrationality? All of them!
Neoclassical: Yes, in goods, you would expect a shortage if a price was artificially lowered (Mercedes-Benz vehicles being legislated at $1,000/car would cause a shortage, for instance). But, clearly, you are not telling me that lowered interest rates create a shortage in credit, right? So, obviously, your example is idiotic.
Yes, in goods, you would expect a shortage if a price was artificially lowered (Mercedes-Benz vehicles being legislated at $1,000/car would cause a shortage, for instance).
But, clearly, you are not telling me that lowered interest rates create a shortage in credit, right? So, obviously, your example is idiotic.
If a legislated low price of money (credit) could not be accompanied with a central authority's ability to create it out of thin air, that would produce shortages just like in your MB vehicle example. You are aware that MB vehicles can not (yet) be created by a mere mouse-click, right?
Daniel Muffinburg:This has to assume to the entrepreneurs would know what the real market interest rate is.
This is a pretty key point, underated I think. This objection belies a larger problem in that Caplan is begging the question when he assumes such things can be known absent a free market functioning to deliver such knowledge. There is no Platonic 'thing' out there we can point to as The Interest Rate. Even the market generated interest could not be said to be such a thing. The market as a system generates the very information to which its participants respond.
Just a quick (preemptive) note to myself and others, regardless of how any of our opponents decide to behave, we should strive to debate fairly in order to give our ideas their best shot. Ridicule and ganging up are really discouraging tactics. I'll only continue to pitch in if something important hasn't been said.
You people are crazy! If you want to abolish Social Security because you predict that people will privately save for their retirement, then you believe in rational expectations!
I don't see the connection, Neoclassical.
Here's the Wiki you linked to:
Rational expectations is a hypothesis in economics which states that agents' predictions of the future value of economically relevant variables, is not systematically wrong in that all errors are random. An alternative formulation is that rational expectations are model-consistent expectations, in that the agents inside the model assume the model's predictions are valid.[citation needed] The rational expectations assumption is used in many contemporary macroeconomic models, game theory and other applications of rational choice theory.
Since most macroeconomic models today study decisions over many periods, the expectations of workers, consumers, and firms about future economic conditions are an essential part of the model. How to model these expectations has long been controversial, and it is well known that the macroeconomic predictions of the model may differ depending on the assumptions made about expectations (see Cobweb model). To assume rational expectations is to assume that agents' expectations may be individually wrong, but are correct on average. In other words, although the future is not fully predictable, agents' expectations are assumed not to be systematically biased and use all relevant information in forming expectations of economic variables.
To put it in a nutshell [as I understand it]. we are to assume that, on the average, people have the ability to know the future of economically relevant variables! I mean really! So if we take poll of what people think the stock market will look like in the future, they will get it right, if we consider the average opinion. Every single day of every single year, from here to eternity.
C'mon, is there any greater madness than such an assumption?
We are against social security because people should be in charge of their own lives. Of course, if someone VOLUNTARILY wants to hand over his hard earned cash to a govt Ponzi scheme, good for him. But to take it from us all at gunpoint is another story.
Also, just because we assume people do not know EVERYTHING about the future, it does not mean we assume they know NOTHING about it. Many people know there is a good chance they will grow old and weak, or just plain reluctant to work, later in life.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
Please forgive what may be a show of my ignorance on the topic; if my following understanding is wrong kindly correct in 3rd grade language, if possible.
I thought the main issue with artificially low interest rates is that it entices entrepreneurs / businesses to take on debt for an unsustainable business model – and the expansion, or new products, would not be “wanted” by consumers if their ( the consumers) credit was not also artificially easy or low.
How can it be about knowing future interest rates – The business must assume that rates will either go down, stay the same, or rise- this is true in a free market or a fed regulated environment.
I sense that I am missing something very basic – please help.
Be responsible, ease suffering; spay or neuter your pets.
We must get them to understand that government solutions are the problem!
Sieben, I totally agree.
And I also think this is a very fruitful discussion, with intellectual honesty on both sides. In contrast to, say, some revleft threads.
Smiling Dave:To put it in a nutshell [as I understand it]. we are to assume that, on the average, people have the ability to know the future of economically relevant variables! I mean really! So if we take poll of what people think the stock market will look like in the future, they will get it right, if we consider the average opinion. Every single day of every single year, from here to eternity.
No, no, no. No one claims perfect forecasting.
Quoting Thomas Sargent's entry in The Concise Encyclopedia of Economics, The concept of rational expectations asserts that outcomes do not differ systematically (i.e., regularly or predictably) from what people expected them to be. The concept is motivated by the same thinking that led Abraham Lincoln to assert, “You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time.” From the viewpoint of the rational expectations doctrine, Lincoln’s statement gets things right. It does not deny that people often make forecasting errors, but it does suggest that errors will not persistently occur on one side or the other.
Economists who believe in rational expectations base their belief on the standard economic assumption that people behave in ways that maximize their utility (their enjoyment of life) or profits. Economists have used the concept of rational expectations to understand a variety of situations in which speculation about the future is a crucial factor in determining current action. Rational expectations is a building block for the “random walk” or “efficient markets” theory of securities prices, the theory of the dynamics of hyperinflations, the “permanent income” and “life-cycle” theories of consumption, and the design of economic stabilization policies.
In essence, you cannot fool investors over and over again using the exact same trick. That's what I'm saying, and that's what rational expectations--as an assumption--would predict.
P.S. I hate to back up my argument with anything that Abraham Lincoln said.
Sieben:In fact, one reason to favor the free market is because it coordinates information and expertise. Capital held by irrational actors is bid away by entrepreneurs better able to use the resources.
Exactly! The repercussion of loss (enfeebled now by bailouts, etc.) is a feedback mechanism that resources were not being used in a manner that increased social welfare; this is a reliable consequence to inaccurate information or even outright stupidity.
My point runs along the same lines: someone might have lost money running a bad business, but I don't expect them to try that same venture over and over and over again. We expect learning to be part of the self-correction in the market. The ABCT believes people can be fooled in the same way, repeatedly and predictably.
The ABCT believes people can be fooled in the same way, repeatedly and predictably.
Obviously not that predictably or it wouldn't happen at all.
It's not a predictive science. ;)
Caley McKibbin:Obviously not that predictably or it wouldn't happen at all.
That's exactly the point that Caplan initially raised and that I, too, am advancing. If the ABCT were true, and if it was first developed almost 100 years ago, then economic actors would have incorporated the information into their decision-making.
What you don't seem to grasp is that the intervention of the government upon the structure of production, is dynamic.
i.e. they dynamically vary their tricks in an attempt to consistently thwart entrepreneurs by messing with price signals in different ways.
Government intervention is not a one shot deal. and of course ultimately entrepreneurs do cotton on to the depth of tricky and this leads to a deflationary depression or a hyperinflation crackup boom.(largely depending on political will to have one or the other)
That is what we call the "perfect knowledge" assumption, another hobbling feature of neo-classical.
Quoting Kevin D. Hooker's entry in The Encyclopedia of Economics, Most economic decisions are forward looking. To know whether today is a day for work or for leisure, we need to decide whether tomorrow will be more or less productive than today; in short, we must have an expectation of the future. How should economists analyze expectations? The new classicals adopted John Muth’s “rational-expectations hypothesis” (see rational expectations). Muth argued that an economic model in which people’s expectations differ from the outcomes predicted by the model itself is poorly formulated. If the predictions of the model were correct—and therefore people’s expectations were wrong—then they could use the model to correct their own expectations. To fail to do so would result in economic losses and would be irrational. At one level, Muth’s hypothesis is just a technical consistency criterion for models. At another level, it appeals to the economic insight that people will not persist in easily correctable, systematic, and costly errors.
Did you catch that? If you have a model that correctly predicts wrong expectations, then that model could be used to correct expectations!
You just keep skating in circles around the bottom line point already made.
Neoclassical: Did you catch that? If you have a model that correctly predicts wrong expectations, then that model could be used to correct expectations! The Austrian business cycle theory does not pretend to be a model whereby data is fed in about this or that particular possible entrepreneurial endeavour, and then a future prediction is made about whether it would be malinvestment(error prediction). so it is not the kind of model that could be used as an error correcting strategy in quite the way you and Caplan would have it. I wonder if that wasn't so obvious that I didnt have to write that... Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring | Post Points: 5
But I think you miss the point, that because of the government interference it sends the wrong signals to entrpreneurs, capitalists etc. It does happen in a similar fashion, only so far as government creates a missalocation of capital goes but it is by no means the same thing every time. Further more, no entrepreneur would be able to predict in such an environment what is being led to by actual demand and that, that is being facilitated by the government missalocation which sends out the wrong signals.
To assume just because we know something is wrong we know at all times where it will be is just fallicious. It assumes a delphic power that no Austrian I am sure whould condone. In fact, from what I have read Austrian come further down against such predictions then many other schools, but what ABCT does say is that there will be a missallocation of capital with government involvement via central banking which distorts individual time preferences etc.
"Man thinks not only for the sake of thinking, but also in order to act."-Ludwig von Mises
Rational expectations theory leads to the conclusion that no deterministic business cycle can persist because it would consistently create arbitrage opportunities. Get that? There would be profitable opportunities that correct the market!
"I've always questioned whether there is such a thing, really, as a business cycle." -- Milton Friedman, echoing a quote I had from Eugene Fama earlier.
I don't see you advancing anything that could be called an argument
Get that?
We get that you don't get it.
What you are saying seems to me, to be saying that it is ok if there is misallocation of capital by the state we can just grow our qay out of it. Don't you think you would run into the problems of capital depletion, regime uncertainty etc. Not only that, it would seem you would surrender to the left liberals as long as you could "grow your way out of it". How would such a theory deal with decreasing capital because of intereference by the state and its misallocations as well as all of the implecations that go with it? Moreover, in his later years even Milton Friedman said he would abolish the fed, what would be the point in that if actors could just learn to go around it. It seems like a non sequiter.
Haha!
What I like most: there's absolutely no sign that any of you are even remotely familiar with neoclassical economics. Question your dogma much?