What about all the stuff that praxeology says nothing about?

[amatchneer]

The Austrian economists have brilliantly described the immutable laws of praxeology, and that there can be no legitimate economic theory that violates these laws. But what about all of the things that praxeology can say nothing about?

I’m towards the end of Human Action (though already well familiar with Austrian theory), and there is, for example, a section that talks about how psychological factors (as opposed to purely praxeological factors) ultimately determine how the originary rate of interest can be permanently altered by a change in the money relation (i.e. an increase/decrease in the supply of money can enrich heavy savers at the expense of heavy consumers, thus resulting in a lasting increase in the amount of saved funds available). Mises is quick to mention that praxeology can’t say anything about this, and that any predictions about the effects in changes in the money relation (aside from the trade cycle, but that’s a separate question) depend heavily on psychological data that is particular to that period of time and other data. Now, I am generally of the mindset that economists generally shouldn’t make policy recommendations based on their own personal inklings (rather than on praxeological truths), but what how should an Austrian react when certain economists place a lot of blame for the recent financial collapse on psychological factors, even if these economists acknowledge the legitimacy of the Austrian Business Cycle Theory? I have frequent arguments with my friends in which they acknowledge that easy credit played a huge role in the crisis, but that even in the absence of credit expansion, investors could still get caught up in irrational exuberance and positive feedback loops and bid up shiny new financial instruments whose inherent risk they don’t fully understand, and that we’d still be faced with a financial collapse due to the poor investments in the housing sector.

The Austrians often point out that one of the central problems of trade cycles to be addressed by economists is the question of how so many entrepreneurs, who generally steer the economy on a course most desirable to consumers, all seem to get it wrong all at the same time. There can be no question that the Austrian Business Cycle Theory explains much of this, but what about the remaining factors, which we supposedly can’t say anything about if we strictly refer only to the rules of praxeology?

The following explanation has been proposed by various Austrians as to how bubbles can’t occur in the absence of credit expansion: in order to bid up heavily a certain investment, speculators must withdraw funds away from their existing investments and put them towards the bid-up investment, which undervalues the other investments in the process, and this creates even more corrective market forces by allowing the smart speculators who aren’t getting swindled by the shiny new investment to buy up all the undervalued investments that the "irrational’ investors left behind. I think there’s definitely something to say for this, but it doesn’t render impossible the notion that “irrational” investors could still abandon their other more reliable investments in favor of the bubble investment, even though I think credit expansion aggravates behavioral factors. Is not economic analysis to a certain degree barren if it doesn’t consider behavioral/psychological factors in addition to praxeological truths?

[Smiling_Dave]

@Alex M

I have frequent arguments with my friends in which they acknowledge that easy credit played a huge role in the crisis, but that even in the absence of credit expansion, investors could still get caught up in irrational exuberance and positive feedback loops and bid up shiny new financial instruments

Right here is where the error lies, I think. Its like saying a gambler who goes into vegas with a five dollar bill will lose a billion dollars because he is so seduced by the glitter of it all. But he only has 5 bucks to spend, duh!

Now if there is someone giving him easy credit, he can borrow a billion and lose it. But if no one is lending him any money, there is only so much he can lose, mainly what he already has.

whose inherent risk they don’t fully understand, and that we’d still be faced with a financial collapse due to the poor investments in the housing sector.

The Austrians often point out that one of the central problems of trade cycles to be addressed by economists is the question of how so many entrepreneurs, who generally steer the economy on a course most desirable to consumers, all seem to get it wrong all at the same time. There can be no question that the Austrian Business Cycle Theory explains much of this, but what about the remaining factors, which we supposedly can’t say anything about if we strictly refer only to the rules of praxeology?

praxeology is not the only thing in the world. if a good psychologist can do research and come up with something useful, more power to him.

The following explanation has been proposed by various Austrians as to how bubbles can’t occur in the absence of credit expansion: in order to bid up heavily a certain investment, speculators must withdraw funds away from their existing investments and put them towards the bid-up investment, which undervalues the other investments in the process, and this creates even more corrective market forces by allowing the smart speculators who aren’t getting swindled by the shiny new investment to buy up all the undervalued investments that the "irrational’ investors left behind. I think there’s definitely something to say for this, but it doesn’t render impossible

praxeology isnt trying to refute every other source of knowledge. quantum physics says there is a small likelihood that we will all sponatneously combust in a huge ball of flame, but that it is highly unlikely. So would you ask “well according to praxeology there would not be a bubble, but it doesnt takeinto account the unlikely event that we all blow up?” OK I know this is irrelevant, but I got amused by the idea.

The real answer is, I think, that indeed nothing is “impossible” in the realm of human behavior. And good ole prax admits that. But it being unlikely in the extreme, it can be ignored. Similar stuff is done in physics all the time, ignoring insignificant forces etc.

the notion that “irrational” investors could still abandon their other more reliable investments in favor of the bubble investment, even though I think credit expansion aggravates behavioral factors.

Is not economic analysis to a certain degree barren if it doesn’t consider behavioral/psychological factors in addition to praxeological truths?

Not barren. Look how it predicted our current recession when no one else saw it. When you do a physics problem about a guy throwing a ball at an angle of so and so, how far will it travel, you ignore completely the psychology of the thrower. Maybe he wil put more effort into it to impress his gf, maybe he’s nervous in his first big game etc. Its all true and important, but certainly the physics books discussing the Mr Normal situation are not barren. They are fruitful indeed.

of course an insightful investigation into the psychology of things would be of tremendous help. Both complement each other, prax and psycho.

[amatchneer]

@Smiling Dave

Now if there is someone giving him easy credit, he can borrow a billion and lose it. But if no one is lending him any money, there is only so much he can lose, mainly what he already has.

You don’t need credit expansion to lend out a billion dollars. Credit expansion definitely makes it easier to do so, but the charge that the investors can irrationally bid up the price of some asset with both their funds and with the funds of similarly deluded creditors still stands. And looking only at the data of the recent crisis, the data does seem to fit. People leveraged the heck out of mortgage-backed securities with borrowed money. Arguably, much of the money was provided by the Fed, but not all, and praxeology can’t say that malinvestment wouldn’t have occurred even if everyone were borrowing at the unhampered rate of interest. Praxeology can only identify the market forces that would make such a thing unlikely.

@Smiling Dave

Not barren. Look how it predicted our current recession when no one else saw it.

Yeah, the Austrians “predicted” it, but as far as everyone else is concerned, we’re perma-bears when it comes to the market, and a broken clock is right twice a day.