25 Jun 2016

Those Silly Austrians Keep Making Econ 201 Errors

Scott Sumner 20 Comments

I can’t remember the course number for Intro to Micro, but I know I never actually taught “101” so maybe it was 201. Anyway, one of the points I would hammer home with the students was to distinguish between a movement in demand, versus moving along the demand curve. I would warn them not to say something dumb like, “The explosion in Libya reduced oil supply, causing the price to rise, which reduced demand, causing the price to fall.”

So, it’s frustrating when Scott writes stuff like this:

Instead, the view that Bullard attributes to monetarists is actually the Keynesian/Austrian view.  It’s Keynesians and Austrians who reason from a price change.  They are the ones who insist that low interest rates are expansionary.

OK, back in 1949 Mises published Human Action. It contained this passage (thanks to David Gordon for helping me find it):

It is necessary to stress this point because it explodes the customary methods according to which people distinguish between what they consider low and high rates of interest. It is usual to take into account merely the arithmetical height of the rates or the trend which appears in their movement. Public opinion has definite ideas about a “normal” rate, something between 3 and 5 per cent. When the market rate rises above this height or when the market rates–without regard to their arithmetical ratio–are rising above their previous height, people believe that they are right in speaking of high or rising interest rates. As against these errors, it is necessary to emphasize that under the conditions of a general rise in prices (drop in the monetary unit’s purchasing power) the gross market rate of interest can be considered as unchanged with regard to conditions of a period of a by and large unchanging purchasing power only if it includes a by and large adequate positive price premium. In this sense, the German Reichsbank’s discount rate of 90 per cent was, in the fall of 1923, a low rate–indeed a ridiculously low rate–as it considerably lagged behind the price premium and did not leave anything for the other components of the gross market rate of interest. Essentially the same phenomenon manifests itself in every instance of a prolonged credit expansion. Gross market rates of interest rise in the further course of every expansion, but they are nonetheless low as they do not correspond to the height required by the expected further general rise in prices. [Human Action, p. 549]

All right so Mises is certainly on to the general concept here (which I read back in high school), and this came out more than a decade before Friedman & Schwartz. It’s not the exact thing that Scott is talking about, but it’s the mirror image and it should certainly be evidence that Austrians aren’t complete idiots when it comes to interpreting monetary policy and interest rates.

(Further, the renewed interest in Wicksell’s “natural rate” is also not new to Austrians–Mises’ theory of the business cycle used this concept as one of its key building blocks.)

What’s super duper weird is the following:

==> Scott and I both agree that if the Fed were to raise its interest rate target by 25 basis points at the next meeting, it would signal a tightening of monetary policy. In contrast, if the Fed were to keep interest rates at their current level, this would be a looser stance of monetary policy compared to the alternative of raising rates a quarter point.

==> Scott and I both agree that the Fed has done things since 2008 that, if not handled correctly in the future, could lead to hyperinflation.

==> Scott and I both agree that if the Fed since 2008 had engaged in our preferred monetary regimes (meaning I think it would be true of my regime, and he thinks it would be true of his regime, but not that we think it would be of the other guy’s proposal), then the Fed right now would have a much smaller balance sheet, and interest rates would be higher than they are now. (See his point 2 here.)

CONCLUSION from the above points: Scott and I both agree that the Fed has done terrible things since 2008, which have made interest rates much lower than they would have been with a sensible policy, which risks hyperinflation, and that if the Fed were to raise rates this year, it would be tightening of monetary policy.

And yet, he continues to quote Milton Friedman and lecture people–including James Bullard if you click his post–on a very elementary point, that I for one first encountered as a senior in high school.

And the ultimate last point I’ll make: In other posts (e.g. here), Scott said that you shouldn’t trust his personal views on monetary theory, but instead you should take the view of the economics profession as a whole. And they right now don’t agree with most of Scott’s views. So…

P.S. I’m firing this off before I go to bed, and it’s hard to convey tone of voice over the Internet. If you read Scott, you know he often makes “jokes” that his commenters don’t get. The above should be taken in that light.

20 Responses to “Those Silly Austrians Keep Making Econ 201 Errors”

  1. Andrew_FL says:

    Mises is talking about the inflation premium. Friedman made and Sumner has extrapolated, quite a different claim-that natural real rates tend to fall as a result of past tight monetary policy, and stay there.

    Actually it’s a far more difficult claim to accept as true. Contra-Sumner, monetary policy should have zero effect on the real natural rate.

    • Bob Murphy says:


      1) I think Friedman also had in mind the inflation premium. I would have to go re-read his stuff, but clearly that is part of the explanation.

      2) But, I anticipated the reply that Sumner is talking real rates not just inflation premium, and so that’s why I put the Wicksell thing in.

      (I know you were not zinging me, just explaining that I was aware of the distinction you are making.)

  2. Tel says:

    The explosion in Libya reduced oil supply, causing the price to rise, which reduced demand, causing the price to fall.

    I get it that this is a throw-away example, and that the textbook would say lower quantity sold means you are sitting at a different point along a static demand curve.

    However, what happens is that short term the demand for fuel is highly inelastic, prices do rise and consumers just suck it up and pay the higher price, perhaps they grumble a bit. However medium to longer term the demand does shift as consumers find ways to streamline their fuel usage (maybe buy a smaller, newer car, or they organize a car-pool or something).

    The analytic approach of having a supply curve and a demand curve and an equilibrium point is a nice way for economists to think about the problem, but you cannot ever really measure the supply curve, nor can you measure the demand curve (these curves exist only in the imagination of the economist). In practice, the “equilibrium” has a dynamic to it that can include all sorts of factors and all sorts of time delays. Great for solving textbook problems where we are given a bunch of presumed curves to work with, but no so good for making deductions about any real world event.

    • Bob Murphy says:

      Tel, deep down, do you really think economics textbooks don’t handle the fact that the demand curve might look different, in the immediate vs. medium vs. long term? Do you really think thousands of economists teach price theory with examples about oil and gasoline, and don’t realize that consumers can economize on fuel usage the longer they have to respond?

      • Tel says:

        I do not doubt that economists have methods to explain it. What I’m saying is that when a layman describes the process briefly and in fairly intuitive words, coming up with a narrative of what happens, I would be reluctant to call that “dumb”.

        The economist describes the same thing in more technical terms, but needs to bring in an extra bunch of mental constructs (i.e. supply curves and demand curves which are not directly measurable, they only exist by inference) and then the economist needs further layers of theory in order to handle the dynamics of the system; and also keeps coming back to poorly defined and poorly explained notions such as “equilibrium” which can mean various things to various people. All up, the trained economist delivers a significantly more complex explanation.

        So the layman has the right to ask, “What additional power is offered by the formal economic description, when the simple hand-waving narrative does the same thing?”

        This is getting off the topic of interest rates somewhat, although the idea that the economy as a whole gradually accommodates to some external supply constraints should be universal, and I would expect that it is quite reasonable to estimate that the US economy has acclimatized to low interest rates over the years. There’s no doubt more elaborate ways to say that, but I’m keeping it brief.

        • Bob Murphy says:

          Ha ha OK fair enough Tel. I didn’t realize you were trying to defend the layman against my pointy headed critique.

          I probably should have added more to the anecdote: I’m pretty sure I had an example where the newspaper article made it sound like the explosion in Libya would have an indeterminate effect on price.

          • Tel says:

            Strictly speaking, I am the layman. Although I’ve done a bit of reading and think that I’ve picked up the concepts, I’ve personally never been attracted to economist jargon.

            Here’s an example from engineering: general Joe Public asks, “What is a transistor?” and you can reply that it’s a bit like a tap that can open and close, thus controlling the flow of electricity.

            Fine so far… but what is the difference between a “bipolar junction transistor” and a “junction field effect transistor”? Now you are talking about two specific designs of tap that have the same overall purpose, but operate internally in different ways. Each one has a jargon name, only to be used for exactly that device. There’s really no easier way to explain the inner workings of one of these devices other than to draw a diagram, show the structure of how it works, figure out the equations, etc. Once you have gone that far, might as well also learn the jargon name.

            Let’s contrast this with an economic term like “supply shortage”. A layman in business might use it, also a journalist might use it, various schools of economics also use it… none of those people mean exactly the same thing by it (although in a hand-waving sense they might have roughly the same idea).

            In a business sense, for example, perhaps China is buying a lot of oil from the world market and driving oil prices up… the American businessman might say their business is facing a “supply shortage” because for them the price of oil is higher than it used to be. It’s a reasonable point of view; it just doesn’t fit the economists mental model of what’s going on there.

            BTW: I’ve got your book “Choice” which I didn’t buy directly from the Independent Institute because although they are quite reasonable on the book price itself, their international costs are a bit off putting.

  3. guest says:

    (OT) HT2 Robert Wenzel.

    Don Boudreaux nails an important point:

    Pity the French Consumer and Worker

    “That is, “pro-business” is commonly used to mean a free, or free-ish, market.

    “But such language is mistaken.

    “A true free market is at its core pro-consumer. In a genuinely free-market economy, businesses are valued only insofar as they serve consumers. The performance of a genuinely free-market economy is assessed by how well it satisfies, over time, the demands of consumers spending their own money and not by how well it satisfies the demands of business owners and managers.”

    Exactly right. And workers are valued only insofar as they serve businesses.

    No business is entitled to workers, to be sure; So the relationship between a worker and employee is a trade relationship, not a hierarchal one.

    • guest says:

      This is why the Keynesian attempt to stimulate demand is necessarily destructive to the economy.

      Their policies cause businesses to produce more than is justified by consumer demand, given the marginal utility to consumers for existing real resources.

      Stimulus programs just cause some people to think they have greater real purchasing power than they do, and so they cause bidding wars for resources that were more or less optimized for prior, unstimulated demand.

      • guest says:

        It might help Keynesians to imagine an economy with X amount of resources.

        Then the “lack of aggregage demand” they fear.

        Then go ahead and imagine their stimulus program, in the context of an unchanged X amount of resources, boosting demand.

        OK, now imagine the same economy with the same lack of demand, and then the same increase in demand without a corresponding increase in supply – but this time without the increase in paper money.

        When you think about it in terms of real resources, it should be obvious why increased demand without an increase in supply is unsustainable.

        Keynesians insert pieces of paper between transactions, and they think that it magically solves this problem.

        • Andrew_FL says:

          In a barter economy, the act of demanding goods or services is one and the same as supplying some other good or service in exchange. “Demand” and “supply” only become distinct concepts in a monetary economy, and only because we decide to arbitrarily call the money side of trades the “demand” side and the goods/services side the “supply” side.

          An increase in demand without an increase in supply of real goods in such an economy is not only not sustainable, it is logically impossible. This was Say’s argument, in essence, contra-Malthus on general gluts.

          Of course, when we introduce money it is possible for the effective money stream to fluctuate in magnitude (or rather, it is not logically incoherent to discuss such a thing occurring) and therefore for the money level of “demand” to increase. Such an thing obviously cannot change the underlying scarcities of actual goods, the real opportunity costs involved in production and consumption choices. Therefore it can ultimately only impact the over all magnitude of the array of prices. Of course it is the task of trade cycle theory to explain the process by which fluctuations in the effective money stream eventually translate to changes in absolute prices, and the effects that occur in between, which are unsustainable because they are merely stages of the process between A&B.

          • guest says:

            “In a barter economy, the act of demanding goods or services is one and the same as supplying some other good or service in exchange.”

            Right. But my point is that you can’t produce just anything and expect there to be a demand for it.

            You have to produce what consumers want if you’re going to get what you want from them.

            In a barter economy, two people must want what the other has. One can’t just say that he spent a lot of time and resources on producing something and therefore it should be acceptable in trade.

            The point of breaking people out into producers and consumers is to defend against the Labor Theory of Value.

            It’s not a denial that we’re all consumers, or that, in a barter economy, both parties to a transaction are both consumers and producers.

          • guest says:

            “Of course, when we introduce money it is possible for the effective money stream to fluctuate in magnitude … and therefore for the money level of “demand” to increase.”

            FWIW, I would chalk this up to a distortion in people’s perception of the real marginal utility of money-substitutes.

            If everyone changed their prices according to increases in the phony money supply, I would say it would be just as impossible to have an increased demand without an increased supply as under a barter economy, because they would know what the money is worth.

            As it is now, people do not (and can not) control for increases in the fiat money supply, and that’s why printing money *works* for the central planners. It’s counterfeiting, theft.

            Under a commodity money, the money, itself, is a commodity, and therefore it is always tending to provide correct information about consumer preferences.

            (Apart from thefts, that is; But when someone is robbed of commodity money, he can’t use it to engage in malinvestments, so the demand for money always corresponds to the demand for real resources under a commodity money.)

            All that to say that I think your point about Say holds in all circumstances, inasmuch as it is possible in a barter economy to make business errors.

            The errors in a barter economy don’t disprove your point about Say – the effects of spending beyond one’s means (analogous to an “increase in demand without an increase in supply”) are felt more immediately and are soon corrected.

            (The same errors are happening under a fiat money system, but there are not corrected for because the errors are not yet apparent.)

            • Andrew_FL says:

              guest-“But my point is that you can’t produce just anything and expect there to be a demand for it.”

              Right. In a barter economy we’d say there’s no guarantee you’ll find a double coincidence of wants, in a monetary one there’s no guarantee your produce will command a positive price sufficient to make the exchange desirable.

              “FWIW, I would chalk this up to a distortion in people’s perception of the real marginal utility of money-substitutes.”

              I think the distortion is of the mechanism by which others preferences are communicated to each consumer and producer. In particular an increase in the effective money stream distorts the prices-in this case, interest rates-which communicate implicit information about others’ time preference. People generally correctly perceive what their money can buy in the moment, the problem is that they misperceive the future scarcity of goods that will result from their current consumption.

              “All that to say that I think your point about Say holds in all circumstances, inasmuch as it is possible in a barter economy to make business errors.

              The errors in a barter economy don’t disprove your point about Say – the effects of spending beyond one’s means (analogous to an “increase in demand without an increase in supply”) are felt more immediately and are soon corrected.”

              There can be in a barter economy excess demand/supply for any given good. We can be more specific and formulate Say’s law in the form of Walras’ law-any excess supply of one good implies an excess demand for another. And if we consider money one of the goods being exchanged, Say’s/Walras’ law will always be true, and if follows that an excess supply of money implies an excess demand for goods-and the effect I stated earlier causes this excess demand to manifest as overconsumption and malinvestment.

              By the way guest I really have to thank you for hammering the imputation issue ’cause I think I’m going to use it in something I’m writing up. I’m tentatively thinking “An Austrian view of “aggregate supply”-Production goods and the Theory of Imputation”

        • Patrick Szar says:

          Sounds like Bob’s Krugman/Sushi tale. That was a big help for me picturing the real flaws of stimulus, whether fiscal or monetary.

    • guest says:

      Walter Block thinks Rothbard disagreed with the concept of “consumer sovereignty”, but he didn’t:

      Walter Block on Don Boudreaux: The Consumer vs. Individual Sovereignty

      “Here, he erroneously supports the idea of consumer as opposed to individual sovereignty.

      “Murray Rothbard’s critique of this doctrine in Man, Econ and State is the corrective for Don’s error here.”

      I ran a search for “consumer sovereignty” in MES, and this is what Rothbard said:

      “12This “rule” by consumers’ valuations holds in so far as entrepreneurs and owners of factors aim at maximum money income. To the extent that they abstain from higher money income to pursue nonmonetary ends (e.g., looking at one’s untilled land or enjoying leisure), the producers’ own valuations will be determining.

      “From the general praxeological point of view, these producers are to that extent acting as consumers. Therefore, the full rule of consumers’ value scales would hold even here.

      “However, for purposes of catallactic market analysis, it may be convenient to separate man as a producer from man as a consumer, even though, considered in his entirety, the same man performs both functions.

      “In that event, we may say that to the extent that nonmonetary goals enter, not consumers’ values are determining, but the values of all individuals in society.”

      So Rothbard’s work isn’t corrective of Boudreaux.

      The point of bringing up the concept of consumer sovereignty is to show why protecting producers from competition is economically destructive.

      The attack on laissez faire in this case is done from the paradigm of producers vs. consumers, and so defenses must address this concern.

      One does not need to deny that everyone is a consumer to hold that the concept of consumer sovereignty is useful in certain contexts.

      • Bob Murphy says:

        guest, I haven’t read Don’s piece or Walter’s critique. But it’s not a distortion for Walter to say that Rothbard did not think “consumer sovereignty” was a good label and gave a misleading focus.

      • Bob Murphy says:

        (So to be clear, it’s possible I would agree with you that Don’s piece is fine vis-a-vis Rothbard, I’m just saying your comment makes it sound like you’re saying, “Rothbard didn’t reject consumer sovereignty as a concept,” when he explicitly said he was, though he did appreciate the point Hutt/Mises were making with that term.)

      • Andrew_FL says:

        I hope, even given Bob’s caveats, that you take it as an intended compliment if I tell you I think of you as “Mr. Consumer Sovereignty,” guest.

  4. Guillermo Sanchez says:

    Nice post, Bob. By the way, I get some other quotations from Mises, Rothbard and Salerno here: http://econo-miaytuya.blogspot.com.ar/2016/06/scott-sumner-is-wrong-on-austrians-and.html

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