Bryan Caplan  

What the Mainstream Can Learn from Rothbard's Monetary Econ - and What Rothbard Should Have Learned from the Mainstream

Selection and Politicians... What Rothbard Missed: Error or...

I just read Murray Rothbard's The Case Against the Fed, and it brought back to mind my youthful exposure to his whole approach to monetary economics. (See here, here, and here for more). My mature view is that there are a couple of big lessons that Rothbard teaches better than anyone; at the same time, however, there are important mainstream results that he failed to grasp.

Let's start with what the mainstream can learn from Rothbard:

1. Government action is the reason why inflation exists. The monetary base is under the Fed's complete control, and it virtually always goes up. Thus, if the Fed took no action, inflation would almost always be lower. In fact, as George Selgin emphasizes, the natural tendency of a growing economy is mild deflation.

If you think this is obvious, let's see what happens if inflation gets much higher. Not only will the public hunt for scapegoats; but even a lot of economists will avoid pointing the finger at the Fed. (And needless to say, the Fed will not point the finger at itself!)

2. The Fed (like all central banks) virtually never "fights inflation." Of course, sometimes the Fed creates less inflation than at other times. But popular talk about the Fed moving into "fighting inflation" mode is pure obsfucation. It makes about as much sense as saying that an orange farmer who cuts back orange production by 20% is "fighting oranges."

If you've taught monetary for years, you may dismiss this as obvious, too. But when I was an economic novice, it was a revelation. And if you don't hit your students over the head with it, most of them will never get it.

OK, now here's what Rothbard should have learned from the mainstream:

1. Seigniorage is a trivial fraction of the U.S. federal budget. Contrary to Rothbard's extravagant claims, printing money accounts for only about 1-3% of the federal budget. There are some Third World countries where Rothbard's "conspiracy" theory is quite right. But in the First World, the government has much easier - and less unpopular - ways to pay the bills.

2. Although central banks cause inflation, central bank independence reduces inflation. In The Case Against the Fed, Rothbard joins with populists who object to the Fed's political independence:

Absolute power and lack of accountability by the Fed are generally defended on one ground alone: that any change would weaken the Federal Reserve's allegedly inflexible commitment to wage a seemingly permanent "fight against inflation." This is the Johnny-one-note of the Fed's defense of its unbridled power.
Unfortunately for Rothbard, there is solid evidence that Johnny-one-note is right: Central bank independence does lead to lower inflation. If the Fed did nothing, inflation would be lower than today; in fact, we'd probably have deflation. Nevertheless, letting elected politicians boss the Fed around would make inflation higher than it already is. The economists who run the Fed are not inflation hawks in an absolute sense, but they are hawkish relative to elected leaders. After all, our elected leaders win by catering to the economically illiterate voters who cry "Do something, government!" every time the economy hiccups. In contrast, the typical staffer at the Fed understands the long-run neutrality of money.

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COMMENTS (7 to date)
D.B.Lambert writes:

He also should have had a better understanding of rational expectations and the efficient capital markets hypothesis. Sure these have their troubles, as behavioral economists are wont to point out. But at least RE and ECMH do not presume that the speculator and the businessman are complete morons regarding the Fed as Rothbard seems to presume.

Koen writes:

I must disagree with dr. Caplan and D.B. Lambert.

Yes, 'seignorage' is only a tiny fraction of the entire US budget (idem for European countries). But the continuous credit expansion by central banks is constantly pushing interest rates below the natural rate. Aren't Open Market transactions usually carried out by buying or selling gov't securities (treasury notes etc)?

Pushing the interest rate down is a way of helping governments spend more than they take in by taxation, as Mises and Rothbard have explicitly mentioned time and again. (Especially in wartime, keeping the interest rate low is an attractive way of financing deficit spending.)

Also, Rothbard did not hold the view that businessmen are complete idiots, constantly being fooled by monetary policy. I can't see how anyone who is familiar with, say, Rothbard's "America's Great Depression", could maintain this.

(The idea that businessmen should be smart enough to foresee monetary policy and its effects, has been used as an argument against Austrian business cycle theory; I believe it is sufficient to point out that businessmen, even when they are familiar with the Mises-Hayek-view of economic crises, do not decide as a group what they will do next. Even if an entrepreneur was completely aware of the fact that interest rates had fallen because of monetary intervention, it would still be rational for him to embark on investment projects, thereby lowering his costs and obtaining a competitive advantage).

Nacho Bizness writes:

The two insights you cite were not unique to Rothbard. Milton Friedman and others have always said this, and Friedman and Schwartz actually did more than rant about it, they proved it. This much is true about all the libertarian monetary economists: where they differed from Friedman, they were wrong.

Why do you suppose there aren't many citations of Rothbard or Von Mises in monetary economics texts? Is the profession stupid?

liberty writes:

"Why do you suppose there aren't many citations of Rothbard or Von Mises in monetary economics texts? Is the profession stupid?"

These two cites weren't unique to Rothbard, I agree. And regarding Rothbard, he did rant a lot.

Regarding Mises, though, he made several unique and important contributions and refrained, generally, from ranting. Although, he used funny terminology that often sounded more harsh than it was meant.

There is no excuse for the lack of cites to Mises, except that the professor is still sore from losing to him in the calculation debate. As Boettke, I think, recently pointed out: Austrian economists cannot gloat about the profession finally admitting defeat at their feet, but Austrians can take solace that the profession has in fact taken to heart every one of their critiques.

A good number of those critiques either was started with Mises or was first completely elucidated by him.

Julian Fondren writes:

"Is the profession stupid?"

Yes. How else do you explain the persistence of Keynesian economics? These are people who think that broken windows are good for the economy, that war spending is a good way to handle a sudden discovery of mass malinvestment, that consumption and not saving is the source of increased prosperity. Part of the profession aspires to be the King's astrologer; part of the profession acts as if it were an economy-oriented mass-psychologist; part of the profession ridiculously suggests that we needed Friedman's hypothetical approach to economics to prove that the Fed is the source of inflation, and can 'fight inflation' only through restraining its own monopoly on the practice.

Renato Calisto Drumond writes:

An analysis of Rothbard's opposition to NAFTA would be interesting too.


In view of recent events, including multiple Fed bailouts under funny acronyms, the idea that the Fed is independent is a bit of a joke.

They just have a very defined constituency: Banking interests, Wall street, etc

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