Old fashioned Keynesianism, as practiced by the likes of [Paul] Krugman, resembles a set of religious dogmas, not scientific propositions. Austrians view economics as a science, a body of theory and application that helps us understand the world. Keynesians see economics as a set of political tools useful to rationalize and justify an a priori faith in unlimited government. Krugman, like Keynes himself, dislikes businesspeople, consumers, and especially entrepreneurs and investors, and prefers a world in which an elite cadre of intellectuals and bureaucrats controls most investment, production, and consumption decisions. Fine, everyone has a right to his personal belief system. But let’s not pretend there’s anything scientific about the multiplier, the marginal propensity to consume, the liquidity trap, and the other relics and sacraments of the Keynesian religion.
don’t reveal preferences, they reveal expectations.
No they reveal preferences ex ante. Whether said preferences actually end up meeting those expectations is an ex post consideration.
But how do you determine if the preferences were based on the actual result or a different expected result? People don’t prefer making one decision to making another decision, they prefer the expected payoff of a particular decision.
For example, back before the FDA or any kind of medical regulation, there were “doctors” who went from town selling snake oil - a remedy that they alleged cured all sorts of ailments. People bought it with the expectation that it would cure those ailments. More often than not, the snake oil did absolutely nothing. If you’re seriously suggesting that people’s purchase of snake oil demonstrated that they preferred snake oil itself to whatever else that money could have gone to buying (food, for instance) - rather than the expected benefit they believed that they could derive from the snake oil - you’re just ignoring truth in order to make reality fit your preconceived theory.
herp derp but when Austrian economists speak of action they are referring to action and preference at a specific moment in time. So when people were buying snake oil they were indeed revealing a preference over food at that given moment in time.
But it wasn’t for snake oil. That’s the point. It was for the expected value they believed the snake oil was going to give them. The problem with the Austrian view is that it leaves no room for disappointment.
Again, as has been repeatedly noted: there is a distinction between ex ante and ex post. Every action reveals preferences ex ante, meaning at that moment of action based on expected results. The future is inherently uncertain. This is a fundamental principle of economics, which - since you claim to be an economics instructor yourself - is something I imagine you understand.
As Ludwig von Mises notes in his opus, Human Action:
The uncertainty of the future is already implied in the very notion of action. That man acts and that the future is uncertain are by no means two independent matters. They are only two different modes of establishing one thing. … [T]o acting man the future is hidden. If man knew the future, he would not have to choose and would not act. He would be like an automaton, reacting to stimuli without any will of his own.
So, man acts because the future is uncertain and wishes to lessen some perceived unease or to attain a greater level of happiness or contentment. As such, every action reveals a chosen means to a specific end but the action cannot guarantee that end: ‘If I buy this water, my thirst will be quenched’, ‘If I wink at this girl, she’ll come home with me,’ ‘If I vote to outlaw guns, there will be no crime,’ ‘If I buy this alarm system, my home will be safer,’ ‘If I invest in this company, I will become rich,’ ‘If I go to the gym, I will lose weight,’ ‘If use this lotion, I will grow 6 inches,” etc.
Mises, ibid. (emphasis added):
Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life. …
Action is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one. We call such a willfully induced alteration an exchange. A less desirable condition is bartered for a more desirable. What gratifies less is abandoned in order to attain something that pleases more. …
Action is purposive conduct. It is not simply behavior, but behavior begot by judgments of value, aiming at a definite end and guided by ideas concerning the suitability or unsuitability of definite means. …
Action is always directed toward the future; it is essentially and necessarily always a planning and acting for a better future. Its aim is always to render future conditions more satisfactory than they would be without the interference of action. The uneasiness that impels a man to act is caused by a dissatisfaction with expected future conditions as they would probably develop if nothing were done to alter them.
So action is hopefully clear, but Austrians do not take for granted the results. To the contrary, that distinction is discussed thoroughly. The nature of humanity itself, beyond an uncertain future, is imperfect human actors and the ubiquity of imperfect knowledge and imperfect calculation (see my post on The Calculation Problem and Price Theory). Austrians discuss this imperfection ad nauseam, and indeed it is why they note that a decentralization of decision-making would yield optimal results.
It happens again and again that an action does not attain the end sought. Sometimes the result, although inferior to the end aimed at, is still an improvement when compared with the previous state of affairs; then there is still a profit, although a smaller one than that expected. But it can happen that the action produces a state of affairs less desirable than the previous state it was intended to alter. Then the difference between the valuation of the result and the costs incurred is called loss.
The Austrian approach does not make the perfect-knowledge assumption the foundation for [the market-clearing price] proposition; quite the contrary, Austrians base the proposition squarely on the insight that its validity proceeds from market processes set in motion by the inevitable imperfections in knowledge, which characterize human interaction in society.
Murray Rothbard not only fleshes out this distinction between ex ante and ex post, but he compares the market in this sense to democracy/government (and dedicated a fair chunk of Power & Market to this discussion):
Error can always occur in the path from ante to post, but the free market is so constructed that this error is reduced to a minimum. In the first place, there is a fast-working, easily understandable test that tells the entrepreneur, as well as the income-receiver, whether he is succeeding or failing at the task of satisfying the desires of the consumer. For the entrepreneur, who carries the main burden of adjustment to uncertain consumer desires, the test is swift and sure—profits or losses. Large profits are a signal that he has been on the right track; losses, that he has been on a wrong one. Profits and losses thus spur rapid adjustments to consumer demands; at the same time, they perform the function of getting money out of the hands of the bad entrepreneurs and into the hands of the good ones. The fact that good entrepreneurs prosper and add to their capital, and poor ones are driven out, insures an ever smoother market adjustment to changes in conditions.
Consumers are not omniscient, but they do have direct tests by which to acquire their knowledge. They buy a certain brand of breakfast food and they don’t like it; so they don’t buy it again. They buy a certain type of automobile and they do like its performance; so they buy another one. In both cases, they tell their friends of this newly won knowledge. Other consumers patronize consumers’ research organizations, which can warn or advise them in advance. But, in all cases, the consumers have the direct test of results to guide them. And the firm that satisfies the consumers expands and prospers, while the firm that fails to satisfy them goes out of business.
On the other hand, voting for politicians and public policies is a completely different matter. Here there are no direct tests of success or failure whatever, neither profits and losses nor enjoyable or unsatisfying consumption. In order to grasp consequences, especially the indirect consequences of governmental decisions, it is necessary to comprehend a complex chain of praxeological reasoning… Very few voters have the ability or the interest to follow such reasoning, particularly, as Schumpeter points out, in political situations. For in political situations, the minute influence that any one person has on the results, as well as the seeming remoteness of the actions, induces people to lose interest in political problems or argumentation. Lacking the direct test of success or failure, the voter tends to turn, not to those politicians whose measures have the best chance of success, but to those with the ability to “sell” their propaganda. Without grasping logical chains of deduction, the average voter will never be able to discover the error that the ruler makes. Thus, suppose that the government inflates the money supply, thereby causing an inevitable rise in prices. The government can blame the price rise on wicked speculators or alien black marketeers, and, unless the public knows economics, it will not be able to see the fallacies in the ruler’s arguments. …
Another critical divergence between market action and democratic voting is this: the voter has, for example, only a 1/50 millionth power to choose among his would-be rulers, who in turn will make vital decisions affecting him, unchecked and unhampered until the next election. In the market, on the other hand, the individual has the absolute sovereign power to make the decisions concerning his person and property, not merely a distant, 1/50 millionth power. On the market the individual is continually demonstrating his choice of buying or not buying, selling or not selling, in the course of making absolute decisions regarding his property. The voter, by voting for some particular candidate, is demonstrating only a relative preference over one or two other potential rulers; he must do this within the framework of the coercive rule that, whether or not he votes at all, one of these men will rule over him for the next several years. …
While success is the engine that accelerates us toward our goals, it is failure that steers us toward the most valuable goals possible. Once failure is recognized as being just as important as success in the market process, it should be clear that the goal of a society should be to create an environment that not only allows people to succeed freely but to fail freely as well.
To suggest that “the Austrian view… leaves no room for disappointment” reveals a gross misunderstanding (or, more likely, straw-manning) of the “Austrian view.”
Needs arise from our drives and the drives are imbedded in our nature. An imperfect satisfaction of needs leads to the stunting of our nature. Failure to satisfy them brings about our destruction. But to satisfy our needs is to live and prosper. Thus the attempt to provide for the satisfaction of our needs is synonymous with the attempt to provide for our lives and well-being. It is the most important of all human endeavors, since it is the prerequisite and foundation of all others.
— Carl Menger, Principles of Economics
A free society is one in which individuals are free to discover for themselves the available range of alternatives. In his masterly critiques of the theory of central planning, Hayek directed attention to the circumstance that the information available in an economy is always scattered among countless individuals, never concentrated in the mind of a single central planner. Hayek pointed to the need for a social institutional structure capable of organizing the scattered scraps of available information so they can be used for the efficient allocation of society’s resources. The competitive market, Hayek showed us, is a discovery process, one in which society discovers what options are feasible and how important they are.
— Israel M. Kirzner, “Entrepreneurship, Choice, and Freedom”
Central planners cause chaos; free people create order. - Tom Woods
Start video at 7:30. Worth your time, particularly if you haven’t read Woods’ Rollback and Meltdown.
The private sector produces; the public sector consumes.
With some free time today, I thought it would be interesting to visit the Philadelphia Federal Reserve - specifically its “Money in Motion” exhibit. It felt good traipsing around the displays laughing at the content while proudly wearing my Hans-Hermann Hoppe “Privatize Everything” t-shirt. There was even one area that asked people to determine if a federal reserve note was “real money” or counterfeit - I slapped the “fake” button every time. After a while, though, I needed to get out as my nausea was beginning to overtake me.
The exhibit was… whatever the opposite of “honest and enlightening” is. Notably, and of course predictably, the “What is inflation?” display defined inflation as merely “an increase in the overall level of prices,” instead of what it actually is: an expansion of the money supply and that price inflation is purely a consequence of monetary inflation. This, as I have noted many times before, is a purposeful shift in definition to obscure the cause (monetary policy) from the consequence (price increases): “By divorcing the word from its literal origins, [central planning apologists] cloud the direct effect between money printing and the value of money. This is not unlike suddenly using the word dog to instead refer to dog piss.”
But amidst the half-truths, misinformation, and outright lies there was something I found ironically honest, if only the average observer would be able to piece the truth together. In the “Early Money in America” display was a short nugget on wampum:
“Small, rounded shells with holes drilled through their centers were threaded onto strings and used as a primitive medium of exchange between Native Americans. The first colonists soon learned to use this Wampum as money, and they also learned to manufacture it cheaply, causing the first “inflation” in America.”
There it was, the truth about inflation: “they also learned to manufacture it cheaply, causing the first “inflation” in America.” Even those who would believe the obfuscation offered by the Fed’s “What is inflation?” display, if they weren’t mindless, would have to pause and consider this statement - particularly in light of what they likely held in their hands.
You see, upon entering the exhibit, every visitor is handed a small bag of shredded federal reserve notes (which, according to the packaging, “represents about $100”).
In its shredded form this “currency” is useless - which means its lack of value is revealed. Federal reserve notes, which gain their usability only through fiat (or decree), lack the hallmarks that emergent money has shown for millennia. A stable currency has these characteristics: it (1) must be relatively imperishable (retain its value over log periods of time - thousands of years - without decay), (2) must be easily divisible without losing value, (3) must be malleable and ductile, able to be shaped into more convenient and portable forms, (4) must remain stable in a wide range of temperatures and climates, (5) has never been worth nothing (has intrinsic value, or rather value as something other than an intermediary of exchange), (6) must be fungible (an ounce from one source would be equal and identical to an ounce from another source), (7) supply is finite without being so rare as to be difficult to use (relative scarcity), (8) new supply is relatively uncommon and difficult to acquire, (9) has a long-standing history of being used as currency, and above all else (10) free people have used it as a medium of exchange or intermediary of trade.
Federal reserve notes, like the wampum those many years ago, is manufactured cheaply and ultimately worthless on its own - triggering the same inflationary consequences.
When we’re first getting students to think about money and prices, we might say, “Imagine the stock of money magically doubles overnight. Every single piece of currency creates a copy of itself. If you had $30 in your wallet [when] you went to bed, you wake up with $60. Now, after everything settles down into the new equilibrium, you see the community isn’t richer. All the prices doubled.”
But once the student gets that under his belt, you make it more realistic. You point out that all prices won’t just magically double. Commodity prices rise very quickly, whereas labor contracts are more rigid. If an old widow is on Social Security, she is clearly going to lose out, whereas a magician can just jack up the going rate for his performances pretty quickly. So we see that even though “on average” nobody is changed by doubling the money stock, in reality some people benefit and some people lose.
Yet another complication is that in the real world, new money doesn’t come in via a magical increase of currency, nor through a helicopter drop. Instead the government (or the owners of gold mines in a Rothbardian world) gets the money first, and then hands it out to its cronies. The new money then ripples out into the community. It’s best to be the government, it’s second-best to be the defense contractor or Wall Street banker who get sweetheart deals, it’s third-best to be the fancy restaurant that caters to the Wall Street bankers, etc. If you’re running a deli in Boise, you’re going to see your input prices rise before your customers are able to pay more for your sandwiches. So there will be a general redistribution of wealth to the people closest to the money spigot, every time there is a new injection of money that disturbs the price equilibrium.
Finally, to the extent that this new money comes into the economy via the credit market (as opposed to a helicopter drop or, say, running the printing press to pay the Army), then one of the prices that rise early on is the price of bonds. In other words, real interest rates are temporarily pushed down, until the new injection stops and then the price system re-equilibrates. This artificially low interest rate sets off the unsustainable boom.
Deck the Halls with Macro Follies
Considering that the process of coordination, enabled by prices, is repeated again and again for all goods and services produced in an economy, it’s easy to see why many economists are impressed by the problem-solving capabilities of the market.
This coordination process also sheds light on how government policies, collectivist or interventionist, that eliminate or distort these prices tend to make the world a whole lot dumber.
As marvelous as the market economy is at problem solving, in a sense the real genius of the market process is in how it brings problems to people’s attention in the first place. Before you can solve a problem, you have to be aware that there is a problem. This, I believe, is the great insight that Israel M. Kirzner, beginning in the 1970s, contributed to our understanding of the market—in particular, that it is a process of entrepreneurial discovery of error.
One implication of this insight is that government policies that undermine the (admittedly imperfect) reliability of money prices also make the discovery of inefficiencies profoundly problematic: undermining prices casts doubt on the very meaning of inefficiency.
Strictly speaking, an inefficiency exists when, for a given person at a given time and place, the cost of an action outweighs the benefit. We’ve seen that to rationally calculate costs and benefits you need money prices of inputs and outputs, of steel and bridges. So when government erodes private property rights, interferes with trade, distorts prices, and manipulates money, it doesn’t just make it harder to be efficient; it also pulls the rug from under the very ability to spot inefficiencies at all.
Using the rules of arithmetic, for example, it’s easy to see that the statement 1 + 2 = 4 is wrong, but what about _ + _ = _ ? What’s the solution to this “problem”? Is there even a problem here? Money prices fill in the blanks; they “create errors”—i.e., reveal mistakes that no one could see without them—that alert entrepreneurs might then perceive and correct. If mistakes and inefficiencies remain invisible, the search for better ways of doing things could never get off the ground.
In the short run (and this is what is so insidious about the Fed’s artificially low interest rates), all we are seeing is an illusion of economic progress. Specifically, the Fed has manufactured a distortion intended to trap both consumers into spending more and entrepreneurs into investing more, or lengthening their production periods (becoming more “roundabout,” as the Austrian School economists said), as if savings were more plentiful. This combination would never occur in an unhampered, noninterventionist economy for the simple fact that higher consumption would mean higher interest rates (from less savings), which would discourage longer production.
Thus, investment in this illusory economy is malinvestment, or investment that always unravels with the intervention’s inevitable end, due to either untenable credit levels (such as today’s corporate debt-to-asset ratio, still at historic highs) or a resource crunch (rising commodity prices) that eliminates any advantage from printing money; and one or both of these scenarios is unavoidable.
Economic progress requires a chain reaction from lower time preferences: foregone current consumption and a higher pool of savings lowers interest rates and triggers a natural entrepreneurial response, greater productivity, and subsequent economic growth. (The “Paradox of Thrift” that warns of the hazards of higher savings is the nonsensical stuff of the ivory tower.) By circumventing this process, as we have today, we have built but a temporary façade.
This leads to another unfortunate kind of malinvestment, of a higher order, if you will: the malinvestment of an electorate in its political class and their policies. Just as entrepreneurs cannot differentiate between real economic information and monetary illusion, so too the electorate cannot differentiate between the effects of Obama’s fiscal policy (of his historic assumption of debt) and that of Bernanke’s loose monetary policy—and without the latter the former wouldn’t have even been feasible. Both Obama and Bernanke pursue a great economic evil to come, but Bernanke keeps them both cloaked as a great present good.
As the Austrian economist Ludwig von Mises noted, laboratory experiments cannot be performed in an economy; “We are never in a position to observe the change in one element only, all other conditions of the event remaining unchanged.”
This is our grievous position in the United States today, trapped in the status quo by first consequences, by what we can see, due to a cause that we cannot even see. And so we are left to learn from experience, an eventual tragic unfolding of our collective malinvestment. As Bastiat said, “Experience teaches effectually, but brutally.”
Mises started–and in my humble opinion, ended–the debate over whether an economic system based on common or social ownership of the means of production could function with his essay “Economic Calculation in the Socialist Commonwealth.” He demonstrated that it was impossible to know whether a particular production process was wise (resource-optimizing) or unwise (resource-wasting) in the absence of prices for the means of production. His socialist critics accepted this, and Oskar Lange suggested that a statue of Mises be given a place of honor by the socialist Central Planning Board (here is Murray Rothbard with more).
Mises carried his argument step further, though: he argued that these prices cannot emerge without exchange, and exchange in turn cannot happen without private ownership of the means of production. Many economists laud the market for its efficiency properties as free markets generally direct resources to their highest-valued ends while minimizing costs of production. In the Misesian tradition, however, the market plays a much more essential role. It is not merely one of a number of possible allocative mechanisms. Exchange in a free market is an information- and knowledge-generating process. To adapt the title of one of Hayek’s essays, competition in the free market is “a discovery procedure.” This emphasis on the coordinating and knowledge-generating properties of exchange in a free market with secure private property rights is one of the distinctive features of the modern Misesian tradition, which is discussed in a three-part series by my occasional co-author Steven Horwitz (1, 2, 3).
Mises’s arguments, and the arguments of those who have followed him, do not merely undermine arguments for pure, global socialism. They also undermine arguments for interventionism more generally. Economists take a lot of heat for focusing on market exchange and material prosperity, and it is fashionable in some circles to say that “there is more to life than economic efficiency” as if that decides an argument in favor of intervention. Not so: people respond to incentives, even when you don’t want them to, and the knowledge-destroying and incentive-distorting effects of interventionism all too often bring with them unintended consequences that not only reduce economic efficiency but also harm precisely the intended beneficiaries of the intervention.
Economics, like logic and mathematics, is a display of abstract reasoning. Economics can never be experimental and empirical. The economist does not need an expensive apparatus for the conduct of his studies. What he needs is the power to think clearly and to discern in the wilderness of events what is essential from what is merely accidental.
— Ludwig Von Mises, Human Action
Keynesian economics is absurd at its core. It literally claims that the conventional laws of economics go out the window in a “liquidity trap.” (Krugman went so far as to explicitly say that mercantilism works in our current world.)
Because they are based upon a falsehood, Keynesian policies fail empirically, quite obviously to anyone with an open mind. Bright guys like Krugman have to come up with a handful of ad hoc reasons to explain away all of the success stories from his opponents; and he can always point to an unobservable alternate reality to “prove” the efficacy of his own remedies.