Free Capitalist Network - Community Archive
Mises Community Archive
An online community for fans of Austrian economics and libertarianism, featuring forums, user blogs, and more.

Rational Expectations Objection to the Austrian Business Cycle Theory

rated by 0 users
Answered (Verified) This post has 1 verified answer | 6 Replies | 5 Followers

Not Ranked
8 Posts
Points 280
NicolasAugust posted on Fri, Mar 2 2012 2:03 PM

I was searching for rebuttals of the common objection by neoclassical economists made against ABCT: That is, how come entrepreneurs foolishly just respond to the lowering of interest rates hence comitting devastating mistakes rather than possessing some level of rational expectations making them understand that the interest rate is merely being manipulated, hence they should not act upon the lowering of the interest rate.

In my search I found a paper by Roberty Murphy with the title ‚ÄčThe Rational Expectations Objection to Austrian Business Cycle Theory: Prisoner’s Dilemma or Noisy Signal?. Does anyone of you know about similar rebuttals which could be recommended (I have also read B. Stanley's Why Don't Entrepreneurs Outsmart the Business Cycle?) and most importantly: Robert Murphy stresses in the mentioned paper as a note that he "no longer fully endorses the views contained in this paper. Nevertheless, he is making it available for public comment". Does anyone know which parts of his rebuttal he do not any longer endorse?

Thank you in advance

Answered (Verified) Verified Answer

Top 10 Contributor
Male
4,987 Posts
Points 89,745
Verified by NicolasAugust

Some on here may know of updated articles, but if you get no response, you could ask Murphy himself: http://consultingbyrpm.com/contact-me

Also, it appears to me without any reading on the matter that if entrepreneur A decides to pass up the opportunity of taking extra money available from the government, he will lose ground to competitors who do take it and use it while it is non-neutral. It appears that it's a prisoner's dilemma situation.

Furthermore, entrepreneurs aren't all economists. Entrepreneurs make bad mistakes all the time. If they had to make predictions outside of their field of work (plumbing, computers, home protection), we'd get nowhere.

  • | Post Points: 25

All Replies

Top 10 Contributor
Male
4,987 Posts
Points 89,745
Verified by NicolasAugust

Some on here may know of updated articles, but if you get no response, you could ask Murphy himself: http://consultingbyrpm.com/contact-me

Also, it appears to me without any reading on the matter that if entrepreneur A decides to pass up the opportunity of taking extra money available from the government, he will lose ground to competitors who do take it and use it while it is non-neutral. It appears that it's a prisoner's dilemma situation.

Furthermore, entrepreneurs aren't all economists. Entrepreneurs make bad mistakes all the time. If they had to make predictions outside of their field of work (plumbing, computers, home protection), we'd get nowhere.

  • | Post Points: 25
Top 500 Contributor
143 Posts
Points 2,440

Huerta de Soto already dealt with this theory:

chapter 6 (p. 422)
http://mises.org/books/desoto.pdf

However, entrepreneurs cannot refrain from participating in the widespread process of discoordination bank credit expansion sets in motion, even if they have a perfect theoretical understanding of how the cycle will develop. This is due to the fact that individual entrepreneurs do not know whether or not a loan offered them originates from growth in society’s voluntary saving.
In addition though hypothetically they might suspect the loan to be created ex nihilo by the bank, they have no reason to refrain from requesting the loan and using it to expand their investment projects, if they believe they will be able to withdraw from them before the onset of the inevitable crisis.

Why Don’t Entrepreneurs Outsmart the Business Cycle?

The entrepreneur, then, pursuant to the argument under consideration here, must not only sweep away the fog of years of past interventions, he must also predict what the Fed will do in the future and when it will do it — all while the Fed tries to anticipate what the entrepreneurs will do.
It seems that any entrepreneur who attempts to undertake such investigations would have little time for things such as serving his customers, improving his product and responding to his customers’ preferences.
[...] there would be those who would knowingly borrow at the below-market rates and take the risks associated with the loans. These companies would be those that were undercapitalized, perhaps startups or companies in trouble. In short, they would be the companies that had nothing to lose.

  • | Post Points: 20
Not Ranked
29 Posts
Points 440
Suggested by geniusiknowit

Wheylous pretty much nailed it. Here is Murphy's response to the RE objection of ABCT.

Specifically, Austrians have offered two types of defense against this typical "rational expectations" objection. First, Austrians point out that individual entrepreneurs who know a boom is underway are powerless to prevent their more reckless competitors from taking cheap (or now free) government loans and bidding away scarce resources. Workers don't care whether their paychecks come from genuine saving or from the Fed's printing press, and every few years there is always a fresh crop of naïve employers willing to borrow money and start new projects.

Second, Austrians emphasize that interest rates communicate information to entrepreneurs. The way some critics describe it, you would think "everybody knows" that the true interest rate ought to be 5 percent, and so the Fed's efforts to push it down to 3 percent should be easily corrected. Yet nobody knows what the truly free-market interest rate is. That's why market prices are important in the first place, and why government distortions of these prices lead to real imbalances in the economy.

http://mises.org/daily/3466/Correcting-Quiggin-on-Austrian-BusinessCycle-Theory

  • | Post Points: 5
Top 200 Contributor
Male
432 Posts
Points 6,830

the interest rate is merely being manipulated, hence they should not act upon the lowering of the interest rate.

The argument ignores the real effect of these lower interest rates, namely that the portion of the entrepreneur's wealth and investments that are cash-based now yield a lower return. This acts both as a disincentive for entrepreneurs to own cash, and an incentive for them to risk a larger portion of that wealth elsewhere.

An idealist is one who, on noticing that roses smell better than a cabbage, concludes that it will also make better soup. -H.L. Mencken
  • | Post Points: 5
Top 200 Contributor
Male
433 Posts
Points 6,720

Not to forget:

You can also mention Reinhart and Rogoff's work This Time is Different, that shows how businessmen and economists happily throw away old standards and wisdom and embrace the next boom. (And it's a rather mainstream account, too - the authors with an IMF background are not Austrians.)

  • | Post Points: 5
Not Ranked
Male
18 Posts
Points 270
Answered (Not Verified) Andrew replied on Sun, Mar 18 2012 2:18 AM
Suggested by Andrew

 

Wow, I just lost my post...ugh... I'll try to summarize here:
 
Are you referring to his article here: http://econfaculty.gmu.edu/bcaplan/whyaust.htm at 3.42? 
 
My reponse to the neoclassical argument is simple: the pricing system is too complex to rationally override.  
 
If we had a small economy with just fisherman and fishing pole manufacturers then artifically low interest rates are unlikely to have much of an effect.  However, in a complex economy, it's not easy to see intuitively, entrepreneurs depend on price signals.  
 
Also, as I believe Mises and de Soto mention, how can the individual entreprenuer know that his particular borrowing will lead to his downfall, even if he knows that the system as a whole will suffer significantly.  Is an entrepreneuer seriously not going to pursue his dreams based off the abstraction that IRs are artificially low and he may be affected by that somehow?  No!  
 
I think the neoclassicals have to at least admit - that the more IR distortion and the more time while the IR is distorted, the more likely it is for a recession/depression.  Yes, assuming that some dubious rational expectations are applied, surely, they cannot override the entire complex pricing system.  Such an ability would require omniscience.
 
Humans are not omniscient.  They base decisions off what people demand and the ability to supply which comes from price signals.  Since at the individual level it is impossible to know the effects without omniscience, it is extremely likely a downturn will follow. 
 
If people were omniscient we would never have a business cycle.  Just because there isn't a sudden shock that isn't expected doesn't mean artifically low IRs cannot cause the business cycle.  The degree of complexity matters too.
  • | Post Points: 5
Page 1 of 1 (7 items) | RSS