Austrian Economics Reading Group Session 6 Spring 2010

The last two readings were Murray Rothbard’s “The Austrian Theory of Money” and O’Driscoll and Shenoy’s “Inflation, Recession, and Stagflation.”

Rothbard’s article touches upon several issues: Non-Neutral Money, Mises’ Regression Theorem, the absence of money in an ERE, future issues to explore, and the definition of money.

The non-neutrality of money is one of the most important contributions that the Austrian School has made to the field of Macroeconomics. Unfortunately, it has almost been universally ignored by the mainstream. It is easier to define neutral money and then compare non-neutral money to it. Neutral money is the idea of money having no real effects when it is injected into the economy. The neutral money theorists usually assume a magical helicopter that doubles the money supply over night. People wake up to see that they all have more money, but since everybody has double, nothing real is affected. All that happens is a doubling of prices. Non-neutral money states that such a story is not only wrong, but dangerously misleading. Money is, instead, injected into the economy at specific points and then spreads out from those injection points. The people with the new money are able to enter into the market at current prices and use the new money to bid resources away from their alternative resources. In a stepwise, sequential fashion, prices rise but not in a uniform manner. Those that get the new money first benefit and those who see prices rise, but do not have the new money lose real wealth. In other words, there is a real wealth transfer from those who get the new money last to those who get the new money first.

Mises’ Regression Theorem is the solution to what was called “The Austrian Circle.” When looking to apply marginal utility theory to money, it is noticed that people hold money, not because they use it as a good, but because it is the medium of exchange. In other words, they hold on to it because of its exchange value. Money is held because it has preexisting purchasing power. As Rothbard asks, “if the demand for, and hence the utility of, money depends on its preexisting price or purchasing power, how then can that price be explained by the demand?”

The solution is what is called The Regression Theorem. Mises argued in The Theory of Money and Credit that we need to go back to the point where this commodity money has not yet money. On the day before it was money, it had use value. Then on the next day it had both use value and exchange value. Thus there is no discontinuity as exchange value grows.

Rothbard also pointed out that in a world of perfect knowledge, there is no need for money. Some of the future issues that Rothbard suggests exploring are (1) How to return to gold; (2) free banking vs. 100% reserves; and (3) how should we really measure the money supply. It was on this last point that Rothbard’s America’s Great Depression received its most significant criticism. Obviously, this is a topic for further discussion.

The second essay presents the standard Austrian Business Cycle Theory (ABCT). While this was written in the mid-1970s, it presents the core in a comprehensive manner. Nevertheless, when considering the different areas of Austrian Economics, it is clear that the ABCT has been tremendously improved upon. There are really three levels of exposition of the ABCT today. The first is the basic story placed in the context of artificial boom leading to bust. I have done this here. Then there is the undergraduate level that is found in Roger Garrison’s Time and Money. Then there are the graduate-level articles written in the journals like The Quarterly Journal of Austrian Economics and The Review of Austrian Economics.

Overall, the NCSU Austrian Forum was good. I look forward to next semester’s line up. I am hoping that there will be more students to attend the sessions, but for me the benefit is from forcing myself to read.

Unfortunately we did not cover the text completely, but you are welcome to comment on the remaining articles in this forum.

Austrian Economics Reading Group Session 5 Spring 2010

I have been remiss in my chronically of the Austrian Economics Reading Group for the entire month of April. We covered two readings in each session.

In the 5th session, we covered F. A. Hayek’s second chapter of Prices and Production, which can be found here (pages 223-252); and we also covered Ludwig Lachmann’s article “Complementarity and Substitution in the Theory of Capital” found in Capital, Expectations, and the Market Process, pp. 197-213, which can be found here.

Prices and Production was originally a series of four lectures that he presented at the London School of Economics. The talks were so successful that he was hired to teach economics, which he did from 1931 until 1950.

The power of the second chapter stems from the presentation of what is sometimes called “the Hayekian Triangle.” This was not the first time an economy was depicted in this fashion. Jevons and Wicksell did it before him; and Böhm-Bawerk had also described an economy as ripening stages of capital. However, Hayek's presentation was clearer and established the triangle as an appropriate tool for analyzing the macroeconomy.

The key to the structure of production, the triangle, is that there are definite stages of production. Some things need to be produced before other things can be made. (You can’t assemble a bookcase until after the tree has been cut down.) While the stages are not time specific, nor do they have to have a certain length (of time), they do establish a sequence. Thus, the economist who uses the triangle can represent distortions to the structure of production. For example, the Austrian economist can argue that during a boom, there is a malinvestment (and an over-investment) in two stages, namely the earliest and latest stages, while there is a malinvestment (and an under-investment) in the middle stages. No other economic school has such a conception. The Real Business Cycle Theorists come close, but do not rival the sophistication of the modern Austrians.

The second article might be one of most important overlooked articles in the Austrian literature. Lachmann points out that not only are capital goods substitutable, but they are more often complements. In fact, most capital arrangements consist of complementary capital goods. For example, suppose that I have an axe to cut down the tree and a truck to haul it to the saw mill. The axe and the truck are not substitutes. This point may seem obvious, and it is. However, outside of Austrian economics, capital goods are all perfect substitutes. Capital is reduced to a letter, “K,” and then is assumed to be continuous so we can take the second derivative of it.

Unfortunately, there were no Neo-Classicals who attended that session and so we all just agreed with one another. I was hoping for some debate, but alack and alas, it was not to be.

I will soon cover the last of our Austrian Economics Reading Sessions.