Monday, 27 August 2012

Is there such a thing as an Austro-Keynesian?

Arnold Kling has ended his blogging days recently, and from now on he will just be writing in essay format. Too bad, cause I really enjoyed his wit and brilliance at EconLog. We will still have a chance to read his intuitive pieces, best of which in my opinion are his articles on the "Patterns of Sustainable Trade and Specialization", and his inspiring book on Economics 2.0, entitled "From Poverty to Prosperity" (co authored with Nick Schulz). All of his research can be found here.

In light of this news, I bring forward a following quote from Prof. Kling, from a couple of weeks ago, referring to his long sought idea of calling himself an Austro-Keynesian:
"About four years ago, I described myself as an Austro-Keynesian. Recently, I have been asked about that concept.

One way to put it is that I accept and reject some major tenets of each camp.

From the Keynes camp, I accept the view that financial market psychology is variable (animal spirits and all that) and that market economies are unstable. I am comfortable with a Minsky-Kindleberger view. Thus, I reject what I see as the common Austrian view that the only source of instability in the economy is central bank money-printing.

From the Austrian camp, I accept the view that there is not much that government can do about downturns. I view a downturn as a sudden, widespread realization that certain patterns of specialization and trade are unsustainable. We just have to wait for entrepreneurs to sort things out. Thus, I reject the Keynesian view that deficit spending by the government provides a cure for unemployment. Another way of describing what I have in common with Austrians is that I do not subscribe to the aggregate demand/aggregate supply paradigm.

Because I do not subscribe to AS-AD, I am skeptical of the monetarist (or basic macro textbook) view that a downturn is almost entirely due to a misalignment between the supply of money and nominal wages. Similarly, I am skeptical of the "New Keynesian" view that a downturn is almost entirely due to a misalignment between the money supply and aggregate prices."
I have to say I completely agree, although I wouldn't necessarily call that Austro-Keynesian. Perhaps New Austrian? Since it's popular nowadays to call everything "New", even when it significantly differs with the old philosophy (not to say that New Austiran would differ that much, but it does to some extent). 

Starting from the top, I too believe markets are unstable and are not always efficient, in which psychology plays an important role. But as Kling and Schulz would say: "Markets often fail, that's why we need markets!" I too am growing less fond of the idea that interest rate manipulation of the central bank is the primary cause of business cycle booms and busts. The central bank can certainly distort market signals and to a large extent, but other things have to collide with it to initiate a business cycle bust. I give the role of politics a much stronger emphasis on that point. I guess on that perspective I would put myself somewhere between public choice theory and new institutional economics. New institutional economics can explain the persistence of bad equilibria within an economy, while public choice theory can, in my opinion, offer a good explanation of how good equilibiria can be distorted (this is something I'm currently working on, and was the topic of my Master's thesis, available here as a working paper). 

On central banks, I feel they have moved a long way from the times of von Mises, and have became much more stable. Or to put it in better words, the system became much more dependent on them to create and sustain financial and macroeconomic stability within an economy. In that sense I can see central banks, particularly in some countries, doing more good than bad for the economy. In some developing nations, central bank independence is often the only thing holding the system together (i.e. removing the influence of corrupt, rent-extracting politicians). In The Constitution of Liberty, F.A. Hayek clarifies the point on how we're stuck with central banks, so we might as well keep them as an element of stability: 
"Perhaps, if governments had never interfered, a kind of monetary arrangement might have evolved which would not have required deliberate control; in particular, if men had not come extensively to use credit instruments as money or close substitutes for money, we might have been able to rely on a self-regulating mechanism. This choice, however, is now closed to us. We know of no substantially different alternatives to the credit institutions on which the organization of modern business has come largely to rely; and historical developments have created conditions in which the existence of these institutions makes necessary some degree of deliberate control of the interacting money and credit systems. Moreover, other circumstances which we certainly could not hope to change by merely altering our monetary arrangements make it, for the time being, inevitable that this control should be largely exercised by governments."
Back to marco, I support the Austrian view and reject the Keynesian view of how to respond to recessions, in addition to rejecting the AS-AD paradigm. Here is where I find Kling's PSST theory extremely useful in its groundbreaking assumptions on how occupational heterogeneity eliminates the necessity of an aggregate supply of labour, or how constant reconfiguration of trade and production make the concept of potential output meaningless (basically, the process of constant reconfiguration of new patterns of specialization and trade make all aggregate values useless in the real world - which is a pretty strong and realistic assumption). I also like the idea that production techniques are not known, but that they should be rediscovered by entrepreneurs in a trial and error process. Modeling all these assumptions is extremely hard, which is why Kling states that "the economy is too complex to be solved by equations". Now there's a truly Austrian perspective, isn't it?

I would like to see more research and more effort done in the direction of this theory. Perhaps it's not the best one out there, but it could be well on its way. Calling it New Austrian or Austro-Keyensian - does it really matter? 

6 comments:

  1. Wow, This seems to encapsulate my own views as well. No wonder you and I see eye to eye so many times.

    The Keynesian view of manipulating aggregate demand is immature at best. But viewing monetary policy as all important is also wrong.

    I wonder if the current economic crises will allow a new synthesis of economic thought leading to a new (for want of a better term) General theory which is more accurate than any of the previous schools taken by themselves.

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    1. Thank you, that's good to know!
      As for the new General theory, yes, I'm hoping for that. The last Depression gave rise to new encompassing theories, perhaps this one will do the same. As long as any form of radicalization is avoided.

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  2. new Austrian, ha? I like it! It was about time that one of the most soundest schools of economic though starts developing its sequel.

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  3. Good post, I like how you compare the seemingly incomparable and I particularly enjoy altering the paradigms of macroeconomics (or at least an attempt to do so). I do like Kling though, perhaps that's the reason for my interest.
    Nice blog, keep up the good work

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  4. Great text! I would have never imagined someone would try and combine Keynesianism and Austrian Economics. But Kling does a pretty good job in making that connection. Even though from both his quote and from your text I would say that this is closer to Austrian theory, or at least some modern interpretation of it (which is why, I assume, you use the phrase New Austrian)..
    Well done overall!

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  5. This is a fascinating take, but I still feel that monetary policy plays a much more important stabilization and destabilization role in the business cycle. You mention politics, I assume you mean fiscal profligacy and debt accumulation, but these don't start to pose a problem to the economy until after the bust. And the bust itself is created by low interest rates and credit accumulation. Cheap money and a favorable monetary policy after all initiate higher debt accumulation, for consumers, businesses and the government. And the problem with the current crisis is all the debt accumulated in the past where favorable monetary policy made it all happen.

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