Critique of Austrian Economics
Part I: The Legacy of Friedrich Hayek
Section VIII: The Naïveté of Austrian Economists
Much of what Rothbard, Garrison and other Hayekians write sounds more like moralizing than analyzing. Credit expansions should collapse so they do collapse – inevitably. They are unsustainable! It is this sort of moralizing which makes so many people feel that Austrian economists are naïve. Keen observes: “At least one branch of Austrian economics, associated with Murray Rothbard, has a quite non-evolutionary attitude towards both the existence of the State, and the role of money. The market economy may have evolved, but it seems the State was simply imposed from outside as an alien artefact upon our landscape” (2001, p. 303). O’Driscoll and Rizzo must be frustrated to read this mostly accurate criticism 16 years after they warned Austrians of the same problem (1985, pp. 232-234).
Interest rates are a good example of what Keen means by an “alien artefact.” When it became clear that interest could not be wholly endogenous or exogenous, Hayekians had to define two rates, a natural one and the real-life one decreed by the Federal Reserve. It would be more productive if they dropped the natural rate of interest idea and, instead, focused on how the Fed decides where to set interest rates. Federal Reserve Board meetings do not take place in a vacuum. Interest rate spikes occur when the central banker’s hand is forced. Hayekians need to concentrate more on how and when this happens rather than just declaring that it is inevitable.
Mises, writing not long after the Great Depression, lists three scenarios for interest rate spikes: 1) “a government aiming at deflation [to reestablish prewar gold parity] floats a loan and destroys the paper money borrowed;” 2) “frightened banks are intent upon increasing the reserves held against their liabilities and therefore restrict the amount of circulation credit;” and 3) “the crises has resulted in the bankruptcy of banks which granted circulation credit and that the annihilation of the fiduciary media issued by these banks reduces the supply of credit on the loan market” (1966, p. 566).
Rothbard discusses an inevitable “distortion-reversion process” but says little about how it actually plays out. Apparently forgetting his master’s regression theorem, he declares “the continuance of confidence in the banks is something of a psychological marvel” (1970, p. 867).
Garrison (2001, p. 44) redefines the Production Possibilities Frontier, PPF, to be sustainable combinations of investment and consumption, but says nothing about what is so unsustainable about a credit expansion. Since he defines consumption on the PPF (which is real) to be the same as consumption on the Hayekian triangle (which is nominal), the unsustainability cannot have anything to do with a devaluation of the currency.
So we see that Mises, writing in 1949, was really the last Austrian to make much of an effort to explain or predict interest rate spikes. After that, their discussion of this issue, including Mises’ later writings, increasingly took on the tone of a morality play, with the greedy bankers getting their “inevitable” comeuppance.
Another reason why Austrians seem naïve is their relentless call for deregulation, which often ignores fundamental inequities. This author writes:
In light of the recent scandals, we should point out that there is no invisible hand that prevents dishonest businessmen from cooking their books. For that we need government regulators. And we needed regulations like the Glass-Steagall Act, which prevented conflicts of interest.
But the most absurd example of Austrian economists’ naïveté is their demand for a 100% reserve requirement. Do they really want the government to inventory a bank’s vaults every morning and again in the afternoon to enforce a rule that makes sense to nobody? Since everyone knows that not a tenth that much gold is actually needed, they would just ship it from bank to bank ahead of the inspectors. Even Skousen considers “the problem of bank evasion and the uncanny ability of banks to escape the 100% rule imposed upon them (1977, p. 47)” to be his plan’s major defect.
Free banking is a more workable system since the government does not get involved until someone complains that their attempt to withdraw gold was rebuffed. Provided only that the government’s response is merciless – the case is handled by criminal courts and treated the same as any fraud or embezzlement – the system is self-regulating, without any intrusive inspections. The danger is that they will want to show compassion and the bank directors will learn to rely on that. As Machiavelli counsels:
[A] prince must not worry if he incurs reproach for his cruelty so long as he keeps his subjects united and loyal. By making an example or two he will prove more compassionate than those who, being too compassionate, allow disorders which lead to murder and rapine. These nearly always harm the whole community, whereas executions ordered by a prince only affect individuals (1999, p. 53).