Additional Empirical Postulates.

Economics Economics Questions
1

I’m assuming that you all know that Austrian economics works on the (correct) assumptions that resources, both human and otherwise, are unevenly distributed between individuals and across the world respectively. There are others employed by Austrian economists such as the assumption that firms seek to maximize profit.

However, I’d argue that more empirical postulates are needed to blunt various criticisms. The first pertains to expectations and the second pertains to price and wage stickiness.

Keynes original argument was that investment is governed by animal spirits. This was the result of Keynes’ definition of the interest rate as the price that equilibrates demand for money as opposed to the price that equilibrates demand for and supply of loanable funds. Without any price for distributing resources over time Keynes could only conceive of investment as being guided by the “animal spirits” of entrepreneurs. Now, Austrians reject this, and claim that the interest rate does indeed ensure a distribution of resources over time that coincides with the desires of consumers when it is not interfered with by the monetary authorities. Given this, and the general Austrian argument that expectations are embodied in and reflected by prices makes sense when applied to investment. But I still think it’s possible that if the expectations of entrepreneurs were to change very quickly and very unexpectedly, at the same time, it would lead the economy away from equilibrium. Now, whilst this position may not persist for very long or be very likely at all, contrary to Keynes’ argument, it’s certainly not impossible that this situation might not occur.

The other, and more important issue of wage and price stickiness has impotant implications for Austrian theories of deflation. Fortunately there’s been a lot of work done in this area, even by Austrians. But it seems that most Austrians associated with the LvMI are in favour of deflation (Rothbard, Huelsmann). But if it turns out that prices and wages are sticky then their theory looks a lot harder to salvage.

2

I don’t think this is a complete answer, but one argument to consider is that sticky prices and wages are at least partially a result of inflationary expectations, in which a nominal decrease nearly always means a real decrease. In a deflationary environment, that would not necessarily be the case.

3

Of course, Post-Keynesians and others dispute some of these assumptions. For example, they say that firms use a mark-up pricing procedure that ignores demand to a large extent. And some studies on menu costs show that even small costs in changing prices may make them overly sticky. Although I don’t think these points are as important as they are often made out to be, I really wish that Austrians would not simply ignore them. After all, a lack of Pareto optimal conditions shouldn’t bother us, since these imperfections are meaningless in a dynamic, ever-changing world.

4

Oh. That’s … amazing. Can I have the scientific definition of “animal spirits” ? Do you mind telling me what the scientific definition of “animal spirits” is. I’d like to know what “animal spirits” are when SCIENTIFICALLY considered ?

Thank you.

5

The market is always out of equilibrium, it is always working towards equilibrium.

Whether a market is close to or far from equilibrium the solution is always the same, laisse faire. Any other solution is a move in the wrong direction.

6

Austrian theory shows that there are certain powerful tendencies toward equilibrium. But, at least hypothetically, there could be other tendencies working against those. These might be either cultural or political. In addition, the whole concept of equilibrium loses some of its meaning because of the incredibly fast-paced world we live in. The underlying variables are always rapidly changing. In addition, there are also endogenous disequilibrating events in economies, such as entrepreneurship. That’s part of Lachmann’s critique of equilibrium as I understand it.

7

Any change in conditions. New information, change in preference, etc.

The market, if seen as the process of improving the allocation of resources, presupposes a disequilibrium.

8

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9

The whole concept of ‘equilibrium’ is flawed - it’s an attempt to misapply physics (or something that kinda looks like physics) to human action, IOW positivism.

10

[quoteuser=“Juan”]
The whole concept of ‘equilibrium’ is flawed - it’s an attempt to misapply physics (or something that kinda looks like physics) to human action, IOW positivism.
[/quote]

It depends on what version of equilibrium we’re using. There are so many kinds of equilibrium, some of which did not arise out of physics envy. For example, what about the Hayekian version of equilbrium, where everyone’s expectations are such that they will all be fulfilled? That is an explicitly subjectivist version of equilibrium, which does not treat people as automaton.

11

Still it’s not very realistic IMO. What does it mean that all expectations will be fulfilled ? People make plans - some plans fail, others not - then people make more plans - and more plans - and … there’s never equilibrium …

12

LS, thanks. I think it’s now clear that Keynes ‘scientific’ theories were inspired by Labatt’s spirits …

13

HAY! REMEMBER! CANES WAS A SERIUZ SCIENTIST!

14

Using methodological individualism sticky prices in the absence of price controls is impossible. Supposing demand for money rises. For this to happen an individual must be determined to increase his cash balances. To do this he must either restrict his purchases or increase his sales. Either way some prices must fall. Resticting purchases of good x will lower the price immediately (as compared with what would have been- NB this is a counter factual statement). Increasing sales of y will reduce the price of y. All individuals care about about is specific prices of goods and money’s purchasing power in relation to them rather than a “price level” in general. In restricting his specific purchases he immediately gets what he wants: prices he deems to high are lowered, the purchasing power of money increases, the real value of cash balances rise and supply and demand are brought back to equilibrium immediately.

15

Can you give an example of how/why the expectations of entrepreneurs would just rapidly change at the same time?

16

Juan, have you read Hulsmann’s A Realistic Approach to Equilibrium Theory? It does what it says on the tin to make equilibrium a useful and realistic concept.

17

[quoteuser=“Physiocrat”]
Using methodological individualism sticky prices in the absence of price controls is impossible.
[/quote]

Not true. If menu costs are greater than the discounted value of expected profit from changing prices, then a firm will not do so. If all firms face a minimum menu cost of x, then they will not change prices until the expected stream of profits exceeds x. Therefore, sticky prices are an empirical possibility, especially for small changes in demand. In addition, this shows that expectations will play key role in all economic activity and could hinder the market process. Nonetheless, I still think the mainstream makes too much of menu costs.

18

Rooster, be that as it may, I still don’t think it’s entirely accurate that without an inflationary environment wages and prices wouldn’t be sticky. There seems to be far more reasons for wage and price stickiness than merely expectations concerning inflation. In fact, wasn’t one of the reasons that Keynes advocated inflation that it would be able to deal with irrational behaviour of workers that makes prices sticky downwards. Now, whilst this doesn’t fit with Austrian theory, the New Keynesians have attempted to reconcile this with rationality. Even so, I don’t think it’s an issue one can rule out a priori.

Ziragt, thanks for posting. I’m quite a bit fan of your blog, I’ve been meaning to get into Lachmann for some time. In any case, I largely agree with the gist of our posts. I don’t think Austrians can simply ignore the questions sticky prices resulting from menu costs or long term contracts, for both strategic reasons and those reasons that pertain to the applicability of their theories to the world world.

Jon, I think I’m up to speed on the Austrian views of equilibrium. But thanks for the condescending pointer anyway.

Juan, how is equilibrium a flawed contruct. I’ve not read the paper Physiocrat cited, but I do know that Mises used equilibrium himself. Lachmann, Hayek and Mises all concerned themselves with questions of equilibrium and disequilibrating and equilibrating tendencies in the economy. For Mises the evenly rotating economy was the starting point for analysis a great deal of questions such as the nature of money, interest and profits. The stationary economy was necessary for analysing economic growth and economic decline. To the best of my knowledge, Mises was emphatically not a positivist.

But then again, Tu Ne Cede Malis

  • Ludwig von Mises, crank, socialist, statist, propagandist, positivist

Has a ring to it.

As for “animal spirits”, I’m not really sure I can provide a definition, although I don’t know I have to, I never claimed that entrepreneurs were ruled by animal spirits. I said that unless Austrians state that as an empirical matter (and I believe this is less important that the issue of sticky prices) they can’t rule out that possibiity. If you think I’m way off here, I got this idea upon reading Bill Butos’ discussion of Time and Money. So at least I’m in good company. If you really want an answer to your question (I doubt you do) George Akerlof wrote a book about animal spirits that was released recently. Perhaps your answer is in there.

Angurse, I’m not really sure that I have an adequate answer to your question. But I will note that I believe various government actions may well have adverse effects on the expectations of entrepreneurs that may lead to such sudden shift. I’m fairly certain that this could be supported in history as well, although not entirely sure.

Physiocrate, I think ziragt already answered your point. I still think that you’re working on the assumption of perfectly flexible markets. Regardless of whether or not they curtail their purchases in specific markets or not. If some markets have more flexible prices than others, and a given consumer reduces their spending in both markets, it could still lead to relative price structures that are out of line with the demands of consumers.

LS, thank you for your constructive posting. Perhaps if I were to post in such a way I might be able to retain my “credibility”.

19

Giles, I don’t understand it. As far as I know, the natural interest rate is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future. The market interest rate has a natural part, and a market part, given by the demand for and supply of loanable funds.

So Keynes didn’t hold any idea of natural interest, he just considered that it was the price that equilibrates demand for money.

Am I right?

20

[quoteuser=“Juan”]
People make plans - some plans fail, others not - then people make more plans - and more plans - and … there’s never equilibrium …
[/quote]

I’m assuming that you believe, as do I, that markets tend to clear (at least over long periods). That’s a form of equilibrium that economists use; a balance of forces of supply and demand. That’s an analogy to physics, yet it’s clearly a useful concept. Without this basic concept of equilibrium, what would economists talk about?

Physiocrat: I’ve read that paper, but I don’t think it really helps much. It just provides us with yet another possible version of equilibrium.

Giles: Glad you like the blog! I thought it might be too esoteric for most people.

The main problem with the Keynesian approach of using inflation to deal with price stickiness is that it ignores the fact that there is a vast heterogeneity among markets in terms of stickiness. It’s almost impossible to target only sticky markets, so according to their own theory, inflation would be counterproductive.

Austrians need to accept that the market is not perfect a priori. People are not perfect. Institutions are not perfect. Culture and politics exist and alter the market process. All of these factors would exist, excluding politics, without government. The market process tends to satisfy consumer desires and create prosperity, but there are no utopias.