Arnold Kling  


The Rip Van Winkle Effect... Classifying a Helicopter Drop...

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.

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COMMENTS (21 to date)
Julien Couvreur writes:

Seems to me like your plain Austrian then. I don't know who claims that central banks are the *only* source of instability. Another source is regulation (kidding).

Austrians recognize that there are many natural challenges and difficulties beyond those brought by government. Participants have to deal with those problems. For instance, when people buy used cars they have to factor in their lack of expertise and knowledge. Each of the commonly named market failures is an opportunity for entrepreneurs to find a better solution or arrangement.

That said, Austrians did find a monetary factor to all the big historical bubbles and crashes, which implies that it is a major factor (which is avoidable, thus the focus on monetary policy).

Benjamin Dunphy writes:

Maybe you'd be more Austrian if you admitted that much of the distortions in the economy are a result of redistribution by government and distortion by central banks.

Not to mention the pyramid scheme of the primary dealers extracting newly-printed money from the Fed at near-zero rates and lending it to the US govt at higher rates of return. Such a ruse is like a neverending bailout, sustained by its covert nature.

Michael writes:

@Julien Couvreur
But, Austrians do maintain that free markets have equilibrating tendencies and that market instabilities are due to something external to those markets. Keynesians, in the Minsky tradition at least, argue that the instabilities are rooted within a "monetary production economy."

Joe Teicher writes:

Ben wrote:

Not to mention the pyramid scheme of the primary dealers extracting newly-printed money from the Fed at near-zero rates and lending it to the US govt at higher rates of return. Such a ruse is like a neverending bailout, sustained by its covert nature.

doesn't seem very covert to me. I don't think you need Top Secret clearance to access econlog anyway. If people are not capable of understanding it then that is really their problem isn't it? I don't get what the big deal is. As long as there is an upward sloping yield curve then those that can borrow at the lowest rates should make some decent $s. I think that the "primary dealers" of pretty much any product get to buy it for a lower price than the retail one and make money by then selling it with a markup. I guess not usually to the company that sold it to them wholesale though.

So maybe you object to the whole silly fiction of the treasury borrowing dollars. I agree its a little weird, but if it helps people think that the dollar has value and increases the NPV of seigniorage what's the problem?

Collateral Damage writes:

Interesting blend.

Why are so few journalists able to communicate the range of economic views and the way different camps of theorists get this or that point right, but sometimes some other point wrong?

This range of theoretical distinctions seems completely unknown to the voting public. I can think of few things more important than to explain to voters why economists can and do quite reasonably disagree over theory.

Greg G writes:

Austro-Keynesian? Very interesting. I had thought these were two species so different that they could not produce viable offspring. I will stay tuned to see how this rogue experiment turns out.

Costard writes:

Michael: evolution tends towards survival, yet species often go extinct. Is this a failure of evolution -- or a reflection of the fact that the world is not stable?

Evolution and markets are both adaptive processes. They exist because externalities and instability are not "rooted within a monetary production economy" but are facts of life. You may say it is naive to trust in a process that we do not control or fully understand; but it is utterly Panglossian to pretend that the world exists in equilibrium and that every change is a shock to AD, which we might fix by caging the elephant and tossing him some peanuts.

To wit, intervention corrupts; but undoubtedly, the zoo is a very stable place.

AD writes:

But surely you agree that a large increase in the demand for money, or a collapse in the money supply, will cause a downturn? If so you are really an Austro-Monetarist-Keynesian.

Hitchhiker writes:

"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."

I would reject this also but, I never got this from my understanding of the Austrian view. Perhaps in a perfect world, absent government meddling, this would be true. It is unfortunate that such a system has never existed, nor probably ever will, to put it to the test. I thought Costard summed it up pretty well. I would argue the jungle is a very stable place also. It just doesn't appear as stable at first glance as the zoo.

Mike W writes:

"...I accept and reject some major tenets of each camp."

What an insight!

"If all economists were laid end to end, they would not reach a conclusion." (George Bernard Shaw)


Lord writes:

So if you assume there is little the government can do about downturns, then is it safe to assume you believe there is also little they can do about upturns? If not, what would be the source of asymmetry? If so, couldn't they just take the reverse action? Didn't Volker put the economy in recession with interest rates or was it a bursting bubble? If you claim money is endogenous, you have difficulty establishing government has any effect whatsoever. Austrians like to say government can only do bad, never good, while Keynesians say if government can do bad it can also do good, and a pure endogenousist would say it can do neither.

Ken writes:

So if you assume there is little the government can do about downturns, then is it safe to assume you believe there is also little they can do about upturns?

It's not at all clear how one follows from the other.

If not, what would be the source of asymmetry?

It takes a lot of knowledge to build something, but almost none to destroy it.

Lord writes:

Then are you saying like the Austrians, government can lead the market astray, but it can't prevent it from going astray? What would be the asymmetry there?

Following Minsky, I assume you believe the government did have some power over those recessions during the Great Moderation when it has interest rates to work with, but I assume not at the lower bound, but if inflation were higher, wouldn't it still have interest rates to work with? Or do you believe the Fed can lower inflation but not raise it? Even then, could it simply not lower it? Was the Fed responsible for lowering inflation or was this endogenous to the economy?

Ken writes:

I assume you believe

You seem to like making a lot of assumptions, but very little logical sense. None of what I said implies anything you assumed I believed. You claimed "if you assume there is little the government can do about downturns, then is it safe to assume you believe there is also little they can do about upturns?" Do you care to back up how the second part of this sentence follows from the first? Or how anything I said implies that I believe that the Fed can lower inflation, but not raise it?

Then you asked "what would be the source of asymmetry?", which of course is the asymmetry of knowledge. Was I not clear? Government officials have very little knowledge compared to the collective knowledge of those who actually build things. It takes thousands to make even the most basic of modern conveniences, but only takes a few to slow or disrupt supply chains. Most government officials don't even know that they don't know, thus making blundering decisions, which makes it harder for entrepreneurs to find or act on their innovations.

It takes a lot of knowledge to discover inefficiencies, then even more to reduce or eliminate them. It takes almost no knowledge to create inefficiencies. This in fact is the whole purpose of the SEC; by preventing many types of trades and trades between certain actors, it purposely slows the rate at which information travels through financial markets. Thus, it's very easy for government to "do [something] about upturns"; it can slow, stop, or delay them.

twv writes:

I've been suggesting this kind of thing for years, so I'm almost excited to learn that one of my favorite economists (Mr. Kling) advances the general notion.Before I even heard of Minsky, I figured that financial markets possess a sort of instability built in, and that bubbles would naturally result. I was unsurprised to learn that Vernon Smith found that bubbles naturally emerged in such markets.

Beyond this, though, the question becomes: Why would bubbles get so big to explode so disastrously? It seems that most huge bubbles are accompanied by infusions of cheap credit, as explained by Mises and other Austrians. And the recalculation required after an inflation-fed boom goes bust is explained brilliantly by Mises. I agree that the source of cyclical instability isn't wholly the result of central bank credit - but central bank credit does seem to work its way into most major bubbles.

I dislike the "animal spirits" metaphor, though. The problem at the heart of bubbles appears to be the difficulty in distinguishing the factors going into the value of a financial instrument like a stock - is it because the company has merits that the stock has value, or merely because because investors have glommed onto it? A stock's value is thought of as a natural sign - but a natural sign of WHAT? That's the difficulty, isn't it?

Most folks know (theoretically) that this can be a huge problem. And yet investors do get caught up in trends, perhaps overestimating their ability to make short-term gains, then imputing longevity to temporary upward price movements that too often are little more than a build-up of attribution errors: attribution of "real" value as opposed to investor demand.

Am I missing something? This knowledge problem that sometimes gives birth to frenzy doesn't seem adequately captured by "animal spirits." But the frenzy itself may seem herdish enough.... the metaphor of stampeding lemmings and nearby cliffs comes to mind, but that reference point turns out to be a myth.

Lord writes:

Ken, I am not implying anything. I am teasing out Arnold's thinking about how his model works. In your thinking about creation and destruction I am teasing out your understanding of what lowering interest rates do. In an accelerating inflationary environment, destruction is not necessarily a bad thing, just as creation is not necessarily a good one.

Now if the Fed could only exert control while lowering inflation, then it would be forced into a Minsky moment, and perhaps the attempt to keep expansions long and recessions short does force it into lowering inflation, but it is not apparent why that would be.

Lord writes:

An example would be the Fed in response to recession creates more debt which increases the sensitivity to interest rates and requires keeping them lower, but perhaps what they should do is allow greater inflation during the following expansion to lower the debt load. In this case a lower or even constant rate of inflation would be a step in the wrong direction and it needs to destroy as much debt as it creates during recessions.

Sam Grove writes:

I was not aware that "Austrians" hold that "central bank money-printing" is the only source of instability in an economy, though I have certainly heard critics of Austrian economics make that claim.

Can anyone cite an actual Austrian Economist making such a claim?

Vangel writes:

I am comfortable with a Minsky-Kindleberger view.

I am not at all comfortable with Minsky. While I am an engineer by training and not as familiar with economic theory as many on this site it seem to me that Minsky's Financial Instability depends on the existence of fractional reserve banking and central banking to get the amplification effect that Minsky describes.

The the financial instability hypothesis argues that banking is a profit-seeking activity. Bankers and brokers deal in the issuance and purchase of debt and create all kinds of mechanisms to handle the liabilities that they sell. They create purchasing power out of thin air and increase the money supply. Without these activities by the central banks and the financial system Minsky's amplification is not possible. It certainly would not be possible in a 100% reserve hard money standard.

Philip George writes:

Austrian economics and Keynesianism are two sides of the same coin. Ever since the financial crisis Austrians have been saying that the large increase in money will result in inflation (meaning price increases). Keynesians on the other hand have been saying that since inflation is low there can be more monetary loosening. Both agree that an increase in money supply results in inflation. Where they disagree is in whether we are now living through a period of monetary expansion (as the Austrians insist) or monetary contraction or flattening (as the Keynesians say).

That there can be monetary expansion without inflation is a situation neither Austrians nor Keynesians seem to be able to visualise. Indeed, no camp of economists seems to understand that there can be monetary expansion that shows up mainly in financial asset bubbles rather than in higher prices of real goods and services.

Lio writes:

"Animal spirits":  this theoritical argument to explain human actions sounds flat and empty. If humans are irrational how can humans give rational (valid) explanations about human motivation?

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