17 Mar 2011

Tyler Cowen Embraces ABCT Even More Closely

Economics 32 Comments

I have already blogged about the weird weird psychological event in which Tyler Cowen used Austrian business cycle theory to accidentally predict the financial crisis way back in 2005.

In August 2008, when his colleague Bryan Caplan was congratulating central bankers for their expert guidance of the world economy (can’t find the link, let me know if you guys can find it), Tyler wrote this in the NYT:

Behind every financial crisis there is usually a crisis in the real economy, based in some underlying structural deficiency. Even if the financial crisis is bottoming out, sooner or later the real crisis must be faced.

The fundamental problem in the American economy is that, for years, people treated rising asset prices as a substitute for personal savings….

The third problem is that lower consumer spending will require the American economy to make some shifts. That may mean fewer Starbucks and fewer new homes but more tractor production for export to foreign markets. In the long run, shifting some consumption to investment is probably beneficial to the economy; in the short run it means job losses and costly readjustments.

As Mike Myers said in a Wayne’s World movie looking at his contract, “Yes, yes, I like what you’ve done here.”

OK so Tyler explicitly used ABCT to predict the financial crisis, then as it was intensifying he was ahead of the curve by using passages that pre-emptively plagiarized Murphy columns on what was needed for recovery, and now he (and a co-author) write this (HT2 David R. Henderson):

The story runs as follows. Before the financial crash, there were lots of not-so-useful workers holding not-so-useful jobs. Employers didn’t so much bother to figure out who they were. Demand was high and revenue was booming, so rooting out the less productive workers would have involved a lot of time and trouble — plus it would have involved some morale costs with the more productive workers, who don’t like being measured and spied on. So firms simply let the problem lie.

Then came the 2008 recession, and it was no longer possible to keep so many people on payroll. A lot of businesses were then forced to face the music: Bosses had to make tough calls about who could be let go and who was worth saving….

So how should we interpret the recent trickle of good news? Well, one positive note is that less-productive, laid-off workers are undertaking the needed adjustments. For instance, according to a survey by the Pew Research Center, nearly 70 percent of unemployed workers have already made dramatic changes in their career or job-field choice, or are considering doing so. There also have been migrations out of expensive urban areas and into smaller and less expensive ones, such as Austin, Salt Lake City, and northern Virginia, with relatively high-performing industries and more fluid labor markets.

In other words, the U.S. economy is going through some major structural shifts.

So workers were doing stuff doing the boom period for which they were overpaid and actually wasn’t productive, and now they have to be reallocated to different sectors where they will be making less. I think you guys are familiar with this story, since it’s what I’ve been saying for three years.

The only main difference I can see between Tyler’s explanation and mine, is that I see interest rates serve a very important coordinating function in a market economy, and that if the Fed massively distorts them, we shouldn’t be surprised at massive real distortions in the capital and labor markets.

Tyler rejects this theory, saying businessmen are too smart to be fooled by 1% (under Greenspan) fed funds rates. In contrast, Tyler thinks these smart businessmen don’t mind having zero-marginal product workers on their payroll when they are making a ton of money.

Search your feelings, Tyler. You are descended from the Austrian School. Mises is your father. Bernanke knows you have the power to destroy him. Join me, and together we will rule the blogosphere!

32 Responses to “Tyler Cowen Embraces ABCT Even More Closely”

  1. English Bob says:

    Tyler rejects this theory, saying businessmen are too smart to be fooled by 1%

    And presumably so smart that they know what the interest rate would be without Fed intervention, and are able to plan accordingly.

  2. Jonathan M. F. Catalán says:

    I don’t understand the “real expectations” criticism of intertemporal discoordination theory (what I’m officially starting to refer to “Austrian business cycle theory” as), because it’s not as if entrepreneurs can guess when the bust will occur, and it’s not as if entrepreneurs are not profiting on their investment decisions. Furthermore, it’s not as if entrepreneurs are going to sacrifice their profits for an extended period of time, based only on the notion that at some point the economy will collapse. There are plenty of reasons to believe that you won’t be affected, or that you will be able to profit before a collapse occurs, even if you are aware of intertemporal discoordination.

    • Greg Ransom says:

      Exactly right.

      Makes one believe that a significant cognitive pathology or personal interest is behind the inability to deal with the obvious here.

    • antiahithophel says:

      “Intertemporal discoordination theory?” — that is excellent! It sounds all impressive and stuff.

      I hate to quote Keynes, but he is correct when he says that markets can stay irrational longer than investors can stay solvent. So, let us assume that business owner “A” understands ABCT — or, rather, intertemporal discoordination theory. His competitor, owner “B” is an uninformed Keynesian. Both A and B see plunging interest rates. A knows that things are going to end badly, but while he is contemplating when the bust is going to happen, B is busily enjoying the fruits of cheap credit and expanding his business.

      A is then in a pickle: does he stay on the sideline knowing that the crash will happen and hoping that the crash happens before he is ruined by B; or, does he also partake of the drug of cheap credit, and simply hope that he is able to properly manage his business? In a very real sense, the more that B relies on credit to expand his business, the more pressure comes to bear on A. If the Fed continues his irrational/incompetent/unethical behavior, then A may not be able to last and A may have to match B dollar for dollar.

      Therefore, A may die when B, with the help of the governmental referees, beats A; or, A may die (with B) when the whole thing implodes.

      • Captain_Freedom says:

        If B is investing in such a way that presumes the interest rates convey true consumer time preference, because he doesn’t understand ABCT, then it is not irrational for A to invest in project X if A expects to not be able to get out in time, or to invest in project Y if A expects to be able to get out in time.

        A will invest in whichever project he thinks will earn him profits and avoid losses.

        The problem is that neither investor knows the true market rate of interest. A can guess, and B can assume the nominal rate is the “correct” rate, but both can be wrong, and in a complex economy where there are millions of individual actors, and heterogeneous capital goods, and not one of them knows for sure what the true market rate happens to be, it is inevitable that the investing class as a whole will be misled by flawed information, since the true market rate is simply unobservable.

        It’s like everyone guessing how many crater are on the far side of the moon by looking at the moon with their naked eyes only, and then basing their actions on how many craters they guess.

        Those who invest and are able to make profits for a time become the leaders that others follow (herd mentality).

        Those who own assets that increase in price may believe to be wealthier than a sustainable economy permits, so they step up their consumption, and end up consuming capital.

        It’s not the investors are irrational, it’s that there is no way to be rational because the requisite information is unobservable. Calling investors irrational is like calling blind people slow runners. Give investors their eyesight (ability to see true market information) and they can make rational decisions.

        • antiahithophel says:

          Well, I should have known better than to quote Keynes, because, in so doing, I muddled my point.

          Keynes’ point (I think) was that capital markets may operate in a way that does not make logical sense to an investor, and by the time that investor’s theory is proven true, the investor may be bankrupt.

          I was simply trying to show that just because a person may be right in their understanding of what is happening, that does not guarantee entrepreneurial success. Furthermore, the intelligent thinker may feel the need to do something “unintellignet” due to current economic circumstances that are beyond the intelligent person’s control.

          I did not mean to indicate that the free market was irrational, although I did not spell that out clearly enough.

          • Captain_Freedom says:

            Keynes’ point (I think) was that capital markets may operate in a way that does not make logical sense to an investor, and by the time that investor’s theory is proven true, the investor may be bankrupt.

            Well, OK, but that doesn’t preclude that same investor being the illogical party.

            Keynes’ argument stems from his penchant for wanting the market to be centrally controlled. He perceives market irrationality because that justifies centralized action.

            I was simply trying to show that just because a person may be right in their understanding of what is happening, that does not guarantee entrepreneurial success.

            Point taken, but that’s always true no matter what happens, which makes it a rather trivial point.

            Even things were different, there would still be uncertainty, and success will still not be guaranteed.

            Furthermore, the intelligent thinker may feel the need to do something “unintellignet” due to current economic circumstances that are beyond the intelligent person’s control.

            Is it really “unintelligent” to do something that generates gains in a hampered market that would have made losses in a free market? I argue no. You might disagree.

          • antiahithophel says:

            I am in agreement with you about Keynes. The fact that I have not expressed that clearly enough stems from a scarcity of time and a lack of written clarity.

            You state:

            Is it really “unintelligent” to do something that generates gains in a hampered market that would have made losses in a free market? I argue no. You might disagree.

            No, I don’t disagree. I originally put the word in quotations (“unintelligent”) to indicate that the intelligent business owner may now, because of government intervention, need to do something that, before the government intervention, would have been unintelligent. Or, said another way: the owner may now choose a path that he would not have chosen without government intervention.

    • Captain_Freedom says:


      You can even add “it’s not as if entrepreneurs can guess what the market interest rate ought to be.”

  3. Bob Roddis says:

    The previous two comments are great.

    Once Cowen admits that businessmen have been misled, he’s been outed.

    Tyler rejects this theory, saying businessmen are too smart to be fooled by 1% (under Greenspan) fed funds rates.

    It’s not just the interest rate that misleads although it is clearly the biggest factor in causing trouble. The injection of the new money at different places and different times is going to distort economic calculation. People are going to be misled even if they know Austrian theory. With fiat money, there is not going to be a good measure of time preference or the factors of the capital structure. Cowen knows all this. He also knows that most businessmen are not familiar with the Austrian concept of economic calculation.

    Apparently, Mr. Cowen is not such a good fibber. If he’s allegedly the greatest thing since sliced bread, he’s smart enough to give the NYT what it wants. His rhetoric is tailored to appeal to the Keynesian mind who only thinks in terms of the dangers of price inflation (the go-to anti-Austrian “argument“), not distortions in economic calculation.

    All he provides is a typically weak anti-Austrian argument from a near-libertarian, probably contrived so he can be considered by our elite leaders as a “thoughtful, mainstream libertarian” and get to write for the NYT.

  4. Country Thinker says:

    Perhaps businessmen won’t be fooled by a 1% Fed funds rate, but consumers are ultimately fooled by artificially repressed rates. Businesses are then fooled into thinking people really want all those flat screen TVs!

    • Jeremy says:

      People are also fooled into thinking they can afford it because the value of their assets rises nominally during a boom.

      • Captain_Freedom says:

        People are also fooled into thinking they can afford it because it makes credit financed consumption more affordable.

  5. sandre says:

    Come to Daddy, Tyler.

  6. Greg Ransom says:

    Actually, Cowen does NOT show deep understanding of Austrian cycle theory, to the extent that the most important developments of it is found in Hayek — the “China money” cause is perfectly Hayekian, and is not a counter-example to Hayek’s picture, contrary to Cowen’s repeated false claims. See Hayek, _Monetary Theory and the Trade Cycle_, book IV. This is just one of many examples where Cowen shows deficient competence in the work of Hayek, and seems to have derived his “Austrian cycle theory” mostly from canned versions in Rothbard and Mises. He rejects simplified caricatures derived from Rothbard or Mises, falsely ascribes those views to Hayek, and dismisses Hayek on false grounds.

    Ex-Rothbardian / ex-Misesian one time teenage “Austrians” has special deficiencies all of there own — they are like ex-Catholic one-time teenage Christians. That don’t have a well rounded understanding of Christianity — they only bare the scares of the thing they only slightly understood as teenage fan boys, and then traumatically and emotionally rejected in the process of becoming an adult.

    Byran Caplan is the poster boy of this — try finding a sound or competent remark on Hayek’s work in Caplan. Everything Caplan came to reject in his fan boy teenage love affair with Rothbard he ascribes to every “Austrian” economist.

    Cowen has some of the same proclivities.

    • Jonathan M. F. Catalán says:

      To be fair, I think Cowen is more widely read on Hayek than Caplan. Cowen, at some point, was supposed to be “the future” (whatever that really means) of the Austrian school, according to David Gordon.

      • Captain_Freedom says:

        Caplan is like the teenage Anakin Skywalker. Started off Austrian, but has since been seduced by the dark neoKeynesian force. There are however still occasional glimpses of his good past, but you know he’s got to get worse and experience the dark side fully before he understands and redeems himself in the end.

        Cowen is more like Qui Gonn. He’s still a Jedi, but he doesn’t fully accept what the other Jedis Mises (Yoda), Rothbard (Obi-Wan), Hoppe (male version of Yaddle), and what Murphy (Luke) are talking about.

      • Greg Ransom says:

        Cowen does all sorts of valuable work.

        All I’m saying is that he isn’t a first rate scholar of Hayekian or even Misesian economics — and he distorts their work in ways that allows Cowen to enhance his own reputation.

        Another example.

        Hayej puts changes of risk evaluation right at the heart of his macro.

        Cowen claimed it wasn’t there and “risk” macro provided an alternative to Hayek macro.

  7. Greg Ransom says:

    I think there is a legitimacy issue for Cowen.

    The more he distances himself from the “nutjob” Austrians, the more legitimate and the higher status he has among his professional peers.

    This is a significant reputation issue for Cowen.

    His professional interests are implicated.

    Don’t expect any dramatic “witnessing” for ABCT.

  8. David says:

    Entrepreneur here. “Businessmen” are not a homogenous hive-mind. Some are smarter than others. Some are noobs, some are experienced. Many don’t understand ABCT. Some do. Many are fooled by Keynesianism. Some just follow decent business practices and get by withotu thinking much about economics. Sometimes it helps, sometimes it doesn’t. Most business owners are always in a process of learning. Personally I suspect the average business owner doesn’t understand interest rates … and that interest rate signals function partially indirectly … at least they’re supposed to, but with fake interest rates, the signals are just confused and confusing and you don’t actually know where to invest … this raises risk, which raises the cost of doing business.

    I started my business around 2003 / 2004 (and knew almost nothing about interest rates or ABCT) when the big boom and bubble were in full swing … lots of ‘easy money’ and I was indeed to some extent ‘fooled’ into thinking running a business was easier than it was. I invested some savings from earlier profits in expansion shortly before the crash, based on boom-year-based growth projections … we had some “not-so-useful workers” on our payroll but it indeed didn’t seem as bothersome as times just seemed easier. That’s just human, I think, to tolerate ‘draining’ expenses during good times, but to really feel them when times are tough (similar to how societies ‘tolerated’ insane welfare levels etc. until times got tough, or crazy government employee entitlements).

    Anyway, a bunch of factors combined when the crash came.. customers drying up, no more ‘easy money’ … my business suffered and we eventually had a really close call cash-wise where we nearly went under. Lots of very careful crisis management and stress and new gray hairs later, we managed to pull through. Running the business more efficiently, working harder, getting rid of deadwood, focusing on better quality customers, offering better deals during the recession (e.g. near cost services, in order to just ‘keep paying salaries’), strictly cutting expenses down to the minimum, a bit of luck here and there (some interesting new business, though not entirely luck, more word of mouth), and of course some ‘fake recovery’ leading to spending when customers probably shouldn’t spend, and we’re cash flow positive again and slowly trying to build reserves back up again. A lot of small businesses HAVE gone under … we pulled through, so while I’m by no means getting rich, I try count my blessings, we ‘made it’ through a tough time. Recently I’ve done a lot of studying up about ABCT. It’s colored the way I view things in various ways which almost make me feel a bit more cautious and pessimistic .. but it’s Pandora’s Box, it’s knowledge that is useful to have even if one’s view of the world is left as more complex, unpredictable, unpleasant, confusing. Sometimes a customer will want to spend money on us (or even invest!) and I’ll get a sense they’re actually making a mistake – being fooled by the latest artificially engineered “recovery” and mini-tech-bubble etc. … and it’s harder for an honest guy like me to ‘sell hard’ when I think my customer might be making a spending mistake, but what can you do? I don’t know when a next crash might occur but do feel we need to focus more on a bigger savings reserve to keep us going through hard times. The crash has been unpleasant but in some senses it’s made us better at running our business. But do I feel armed with knowledge that will help me make more money? No, on the contrary, I feel more pessimistic, like the world is too difficult to predict, and that true wealth may be just too difficult to achieve in a world where governments will always, always, always, always in every which way they can, steal the maximum amount possible from folks like us.

  9. David says:

    “… and it’s not as if entrepreneurs are not profiting on their investment decisions”:

    Many entrepreneurs ARE ‘not profiting’ on their investment decisions. We made some investments which just lost us a lot of money. Many businesses have done so, and many businesses have been killed by this. A lot of people lost a lot of money, and many ‘entrepreneurs’ have been as hard hit as anyone else (DOUBLY so … because not just have our businesses been hit, but we also have ALL the same pain that ‘ordinary salary earners’ have seen, such as watching large portions of our retirement savings get knocked out, or ending up with negative equity on our personal property purchases .. entrepreneurs are people). I’m not sure what you’re trying to say there but it looks wrong on the face of it.

    “Furthermore, it’s not as if entrepreneurs are going to sacrifice their profits for an extended period of time, based only on the notion that at some point the economy will collapse”

    I don’t think it’s about sacrificing current profit earnings, of course you keep those where you can, i.e. where you do have income streams and profitable customers, but it’s more about sacrificing ‘potential profits’ by not re-investing profits at all … rather, just saving them … so that firstly, you have a bigger cash buffer to help you survive the next bust, and secondly, because, well, it’s very hard to know where the hell to invest your money these days. So it’s about sacrificing potential GROWTH – i.e. rather keeping your business smaller, and have a smaller business that is making some profit, than risk trying to grow. You’re sacrificing ‘potential future bigger profits’ by not investing in risky growth, because growth is just too damned risky. So you just try keep your savings in whatever will more or less help you hedge against inflation. The prospect of an economic collapse also makes you think, well If the economy collapses or there is another bust, you’ll end up having just spent all this investment money and then ending up having no sales in what you invested in.

    • Jonathan M. F. Catalán says:


      You’ve largely missed my point. The fact that many entrepreneurs were affected doesn’t mean that many entrepreneurs did not profit off some of their investment decisions. During the years of boom, in fact, entrepreneurs were profiting from their investment decisions. Intertemporal discoordination doesn’t just encompass a time period between the end of the boom and the beginning of the bust.

      How you decide to run your business, if you’re operating under the belief of an impending economic collapse, really depends on when you think this collapse will occur. An economic collapse is just another uncertainty that you’re partially aware about, and it adds uncertainty in the fact that you now need to plan between the present and the expected date of this alleged collapse.

      My overall point remains (one of the several points you missed), however, that knowing about intertemporal discoordination doesn’t necessarily mean that you’re going to stop investing.

  10. David says:

    “There are plenty of reasons to believe that you won’t be affected”

    And why on earth would I, as a business owner, believe that I ‘won’t be affected’ by any downturns or crashes in the economy? On the contrary, that is absurdly wrong … I, as an ‘entrepreneur’, am ALL TOO KEENLY aware that I would be very badly hit, as mentioned. Are you saying business owners uniquely somehow live in some weird sort of irrational over-optimistic rose-colored-glasses denial?

    • Jonathan M. F. Catalán says:


      Please, think about this a little bit. If you bought a house in 2004 and sold it in 2006, before the housing market collapse, you would have made a profit off your investment. The realm of “investment” doesn’t just cover those entrepreneurs who were hurt by the recession. It includes investments that were made between 2002 and 2007-08.

      You’re putting words in my mouth, without really understanding what I’m arguing.

  11. Bob Roddis says:

    Bob Wenzel on Cowen:



    Quoting Karen De Coster:

    [R]emember that Cowen is the guy who wrote an article in the New York Times in 2008, and mentioned Mises in this way:

    “Ludwig von Mises, the leader of the so-called Austrian School of Economics…”

  12. Wonks Anonymous says:

    Steven Williamson has a low opinion of Robert Wenzel. The only other site I’ve heard Wenzel’s name is your blog.

  13. Intrinsic says:

    Well said Sir, Well said. Someone had to debunk his logical fallacy.

  14. John Papola says:

    Great post, Bob! Hilarious.

  15. Contemplationist says:

    This is getting annoying. I feel like Silas. Bob, would you be honest enough to go thru the list of predictions
    TC made using ABCT? You could yknow admit which of those did not come to pass and which ones did, then sorta explain them. After all, simply saying “financial crisis – housing” is not sufficient to vindicate ABCT. Those SPECIFIC predictions have to pan out – and many of them didn’t – like the flight out of US treasuries, or the sectoral shift to more exports.
    Are you going to explain this in a scientific manner or continue this propagandistic Krugman-like scheme of pointing to a mixed record to claim victory.
    Oh, not to mention the persistent hyperinflation calls booming from all the descendants of Mises since 2009 onwards. Will there be any honest Bayesian updating or not?

  16. stickman says:

    A bit late to join the discussion and potentially redundant to what you’ve already written, Bob, but some of your readers might be interested in this interview with Tyler: http://www.nationalreview.com/articles/260437/america-s-technological-plateau-interview?page=4

    The relevant snippet:

    SHAFFER: I know your university, GMU, offers some classes on it, but otherwise the Austrian school of economics doesn’t seem to be taken too seriously in most corners of academe. Many of my libertarian friends think that this is a bias. What do you think about academia’s stance toward the Austrians?

    COWEN: Most academic economists have been skeptical of the Austrians. But I think the Austrian business-cycle theory in particular is getting renewed interest, because it is a tale of having a boom and a bust with a lot of credit expansion going on at the same time. In my view, it’s a very incomplete account of what happened, but it’s part of the story. I think it blames too much of what happened on the central bank, when I think there was a private-market bubble, and it wasn’t just because of what the Fed did or didn’t do. But it is one part of the overall explanation, and I think people are beginning to see that.

    Part of the problem is you have a lot of Austrians who overclaim for the theory, where it becomes a kind of religious dogma, where it’s presented in a very take-it-or-leave-it way. Sometimes the Austrians are not the best ambassadors for their ideas. But it’s receiving new attention and it ought to be.

    SHAFFER: Would you call yourself an Austrian?

    COWEN: Absolutely. Austrian economics is what I grew up with. I wouldn’t call myself a capital-A Austrian, but the Austrian economists have been among the biggest influences on my thought — then and still now.