Austrian VS Post Keynesians on ABCT: The Debate

In case that some readers did not notice it, there has been a debate about Austrian Business Cycle Theory (ABCT) between the Spanish Austrian School thinker Dr. Juan Ramón Rallo and the Post Keynesian blogger “Lord Keynes”.

Rallo is specially known in Spanish and Latin (America) world, and he is, in my opinion, one of its greatest Austrian economists. For those English speakers who don’t know him, he is one the bests disciples of Huerta de Soto. However it must be said that, in monetary economics, he is far from his master and the "traditional" Austrian School. Rallo endorses a theory mainly represented by Antal Fekete who founded the so called (by him) "New Austrian School", a supposedly Menger-rooted school about banking maturity mismatch, neo-real bills doctrine, liquidity, Gold Standard, among a lot other things. In other words he is neither a 100% gold-reservist like Rothbard nor a complete free banker like Selgin. Despite I also disagree with him on this, that doesn’t detract one iota of Rallo's greatness. ABCT emerged stronger from the clash of them.

On this blog post are all the links to the debate. Unfortunatelly for English speakers, Rallo's responses are in Spanish. So anyone who can't understand spanish very well can use Google Translate. He also made an excellent refutation of Sraffa's system and value theory.

Finally in a shameless act of self-promotion I will divert you to my personal opinions about the "multiple rates of interest" objections against ABCT (here is the short version, and here is the full discussion) and about "full employment assumption and all that" (here and here).

Lord Keynes refutes “Lord Keynes”

In discussing neoclassical law of demand, “Lord Keynes” reaches some conclusions to try to attack the notion that enforced minimum wage can cause unemployment in exactly the same way that setting a price above what market participants would have established would cause a surplus. Let's see what he said:

"It is clear that the “law” is expressed in terms that are highly artificial and abstract. The phrase ceteris paribus is Latin for “[all] other things being equal.” The factors that must be held constant are vast: incomes, prices of other goods, fashions, expectations, information, preferences/tastes, population, the weather, etc.

So when somebody asserts that the law of demand is universally true, what this means is that, in an imaginary, utterly abstract and artificial world in which “all other things were equal,” demand for a product would always rise as its price falls, and demand would always fall as the price rises.

Yet these types of arguments are absurd beyond words, because

(1) the real world never fulfils the ceteris paribus assumption and hence the law of demand, properly formulated, is irrelevant, and
(2) economies are immensely complex and the level of employment is dependent on many factors well beyond the simple dynamics of supply and demand curves. The demand for labour is dependent, above all, on aggregate demand for products, and this, along with many other factors, would compensate for and overwhelm any reduction in demand from higher wages, even assuming the abstract formulation of the law is true.

It does not follow that minimum wage laws can only ever necessarily increase unemployment at all."

One comment about (1): As far as I know, no one has ever said that “ceteris paribus” is a condition that could exist in real world. Nobody, not even neoclassicals, is so idiot to think that we can freeze subjective valuations, technologies, incomes, prices, expectations, etc. of the 1300 million people of China to see how price of oil behaves.

Notice that “Lord Keynes” has said that the law of demand is irrelevant in real world, only to talk about his own "law" (point (2))!!! But is his “law” based on real world non-ceteris paribus assumptions? The answer is no, according to the real Lord Keynes:

“[I]t may be useful to make clear which elements in the economic system we usually take as GIVEN, which are the independent variables of our system and which are the dependent variables… We take as GIVEN the existing skill and quantity of available labour, the existing quality and quantity of available equipment, the existing technique, the degree of competition, the tastes and habits of the consumer, the disutility of different intensifies of labour and of the activities of supervision and organisation, as well as the social structure including the forces, other than our variables set forth below, which determine the distribution of the national income. This does not mean that we assume these factors to be constant; but merely that, in this place and context, we are not considering or taking into account the effects and consequences of changes in them.”

“[T]he GIVEN factors allow us to infer what level of national income measured in terms of the wage-unit will correspond to any given level of employment; so that, within the economic framework which we take as given, the national income depends on the volume of employment, i.e. on the quantity of effort currently devoted to production, in the sense that there is a unique correlation between the two. Furthermore, they allow us to infer the shape of the aggregate supply functions, which embody the physical conditions of supply, for different types of products; — that is to say, the quantity of employment which will be devoted to production corresponding to any given level of effective demand measured in terms of wage-units." (italics, bold and capital letters added)

That’s right. Keynes has inferred a kind of “law” by holding everything else constant: “the national income depends on the volume of employment”. Amazingly this ceteris paribus “law” is what "Lord Keynes" invoked as his point (2). But that relation is also subject to the condition that ALL other “factors” are “GIVEN”. We can restate LK assertion by saying that “in an imaginary, utterly abstract and artificial world in which all other things were equal, the level of national income will correspond to any given level of employment (his point (2)). And yet these types of arguments are absurd beyond words, because (1) and (2)”. Even Keynes knew very well that the ceteris paribus couldn’t be fulfilled in real world, but that was not a problem for him to assume all other things as “given” in “the place and context” of what he was analyzing.

His own position puts “Lord Keynes” closest to Hazlitt than to Keynes himself. So I don’t think "Lord Keynes" can sleep tonight… Hazlitt said:

“Keynes thinks "it may be useful to make clear which elements in the economic system we usually take as given, which are the independent variables of our system and which are the dependent variables"… Now economics is concerned with human valuations, human decisions, and human action. Everything in the system is a variable. No relationship (unless it is merely two ways of saying the same thing) is a constant. Nothing is permanently "given." Almost anything can be an "independent" variable, in the sense that a change can originate at that point. When a change has originated at any point, then the relationship of nearly all the factors is one of mutual dependence, of interdependence.”

See also some good remarks about "abstractions" and all that from Jonathan Catalán. Also it’s good to see this Daniel Kuehn’s post. Kuehn is a Keynesian, an “open minded” Keynesian, so even when I don’t agree with the whole post (I think that ABCT explains present US and world crisis fantastically well) he made some very good points.

An Austrian praising Friedman!

The Failure of the "New Keynesian"

Nobel Prize Economist and New Keynesian Paul Krugman has a very bad discussion on Hazlitt.

Jeremy Hammond completely destroyed him in this great article. He even shows an old 1987 article in which Krugman blatantly refutes himself. Hammond perfectly points out that “[N]either does Krugman by any coherent and clear-cut argument refute the logic by which Hazlitt concluded that eliminating minimum wage laws would have benefited workers by allowing them to gain employment during the Great Depression. He simply declares Hazlitt “wrong about everything”, cites an irrelevant quote from Keynes, and then goes on to cite Irving Fisher to bolster his assertion that following Hazlitt’s advice would have made things “worse” and the “overall effect” would have been “to deepen the depression.””

I will show evidence that Krugman either never read Hazlitt or, if he did it, he deliberately misled his readers. In other words: either he is an ignorant talking about an author he never read or he is a dishonest person.

Krugman writes:

“Anyway, Bartlett focuses largely on the malign influence of Henry Hazlitt, who was among other things writing many editorials for the New York Times, always insisting that the answer to the Great Depression was to encourage big cuts in wages.”

However in his devastating and complete refutation of Keynes' book, Hazlitt wrote:

“Now in a free (non-statist, non-socialist, non-totalitarian) economy, wages do not and cannot adjust themselves en bloc, as a unit, by some neat, fixed, round, uniform percentage. Nor do prices adjust themselves en bloc, by a uniform percentage or as a unit. Nor does production adjust itself en bloc or as a unit. In a free economy there are millions of daily adjustments of one wage-rate to another, of one price to another, of this wage-rate to that price, of that price to this wage-rate. There is constantly going on in a free economy, in brief, an almost infinite number of mutual adjustments. This is how the economy works...

But all this conflicts with the simplistic theories of Keynes. He thinks in aggregates, in averages, in abstractions which are mental constructs that have lost touch with reality. He thinks, in short, in lumps. He deals only in his own lump-concepts like average-"level"-of-wages, average-“level''-of-prices, aggregate demand, aggregate supply... Keynes cannot understand a free economy precisely because it does not consist of such lumps. Having reduced everything to averages, he cannot understand any adjustment, he is even against any adjustment, that is not a uniform adjustment of each of these averages, blocks, lumps, to the other." (my bold)

If this is not enough for you, here come the best:

It is important, finally, to point out that no real adjustments of wages or prices are ever made, upward or downward, in the flat uniform simultaneous way in which Keynes implies they are made or ought to be made.

A Keynesian statistician, relying on averages and aggregates, would declare "wages" to be in equilibrium. Yet the wage-rate of none of the four industries would be in equilibrium. The solution, for a restoration of equilibrium and full employment, would be a mutual and multiple adjustment of particular wage-rates.

Always what is relevant to economic equilibrium and full employment is the relationship of particular wages-rates to other wage-rates, of particular prices to other prices, and of particular wages to particular prices; never of averages to averages, or of the wage 'level" to the price "level." Such mathematical averages or average levels do not exist in the real world. They are mental constructs;8 they are fictions; they conceal the real maladjustments in any given economic situation, or make them appear to cancel out.

It is clear as water that Hazlitt was saying that employment will be restored if PARTICULAR wage rates go down, He is not suggesting that ALL wages must to go down. Actually the reduction must not be a big and uniform one. He even used an example to demostrate that it would be a great mistake to push down all wages to combat unemployment. Hazlitt had never said in his whole book that all it was needed to combat unemployment was that THE wages go down as Krugman makes his readers to believe.

It took me around 20 minutes to find all this just using Acrobat’s word searcher. It was that easy, Krugman also could have done it.
 
Krugman says that: “Bad ideas, it appears, are extremely robust in the face of contrary evidence.” Here he is right, bad ideas like replacing Nasdaq bubble with a housing bubble (again in 2006). But hey! He was just "joking"

This is exactly the same kind of dishonesty that made his “master” to review a german written book when he couldn’t speak german very well... see here, here and here