Rothbard on the Depression
By Arnold Kling
I started to read it. Should I finish? Some excerpts and my comments.
the timidity and confusion of Reagonomics make very clear what its choice will be: massive inflation of money and credit, and hence the resumption of double-digit and perhaps higher inflation, which will drive interest rates even higher and prevent recovery. A Democratic administration may be expected to inflate with even more enthusiasm. We can look forward, therefore, not precisely to a 1929-type depression, but to an inflationary depression of massive proportions. Until then, the Austrian program of hard money, the gold standard, abolition of the Fed, and laissez-faire will have been rejected by everyone…Perhaps, this present and future economic holocaust will cause the American people to turn away from failed nostrums and toward the analysis and policy conclusions of the Austrian school.
That is from the preface to the 1983 edition, written in September of 1982. What are we to make of this Jeremiad? To me, the prediction in hindsight seems embarrassingly bad. What followed was the opposite of an inflationary depression. Instead, we had the Great Moderation.
Or shall we say that the past five years are a vindication for Rothbard? Hard-core Austrians would say, “We told you so. The Fed distorts patterns of production, creates booms, and then–crash! Fits our model exactly.”
The problem for me is that they always tell us so. They always predict horrible macroeconomic events, just as the Marxists always used to predict ever-worsening crises for capitalism. If crises are a refutation of orthodoxy, then periods of normal growth can be refutations of heterodoxy.
Suppose a theory asserts that a certain policy will cure a depression. The government, obedient to the theory, puts the policy into effect. The depression is not cured. The critics and advocates of the theory now leap to the fore with conclusions. The critics say that failure proves the theory incorrect. The advocates say that the government erred in not pursuing the theory boldly enough, and that what is needed is stronger measures in the same direction. Now the point is that empirically there is no possible way to decide between them. Where is the empirical “test” to resolve the debate?
I would say that paragraph (emphasis in original) is indeed genuinely prophetic.
It is the well-known fact that capital-goods industries fluctuate more widely than do the consumer-goods industries.
Emphasis in the original. However, contra Rothbard, this is not a point of distinction between Austrians and Keynes. Keynes also locates the source of business fluctuations in business investment–he posits “animal spirits” rather than monetary distortion as the cause. Interestingly, Ed Leamer is emphatic in Macroeconomic Patterns and Stories that business cycles do not originate in the investment sector. “It’s a consumer cycle, not a business cycle,” is his mantra. On the other hand, the consumer cycle does manifest itself in housing and consumer durables, which allows for interest rates to play a causal role.
My main problem with the Austrian theory is that it presumes that businesses are highly myopic. An entrepreneur should be able to tell when the central bank is keeping interest rates too low. In that case, he should not say, “Oh, boy. Let me commit to long-term production based on these low interest rates.” Instead, he should say, “I’d better be careful. These interest rates are artificially low.”
I would be the last person to insist on rational expectations. But it does seem to me that rational expectations would destroy the Austrian channel for money to cause the business cycle. On the other hand, if you get rid of rational expectations, then all sorts of other things besides money could cause the business cycle. Why privilege the central bank as the only source of bubbles, the only locus of mistaken beliefs by entrepreneurs?
[UPDATE: Thanks to commenter Rod Long for pointing to Gene Callahan, who looks at the rational expectations critique of Austrian economics. Obviously, I am not the first person to think of this issue. Callahan rejoinders,
Even if we somehow did know that on, for instance, July 12, 1995, the interest rate was at its natural level, how could we relate that fact to what the rate should be now? Fed watchers might be able to tell entrepreneurs that the Fed is easing. But is it easing toward the market rate of interest from some level above it, or further past the market rate from some level already below it? The idea that entrepreneurs are committing significant errors by not somehow divining where the rate ought to be is to criticize them for lacking superhuman capacities.]