The Circle Bastiat
Gerald P. O’Driscoll’s hard-hitting piece in today’s Wall Street Journal, "Debunking the Myths about Central Banks" is well worth reading. Among others, O’Driscoll addresses the myth that “central banks are intrinsically necessary for market economies.” As O’Driscoll points out, however,
"A gold, or any commodity, standard places a natural limitation on money creation, which is the resource cost of extracting the commodity. It is only with fiat (paper) money that central banks are necessary to control the money supply."
One should not conclude from this that O’Driscoll fallls prey to the myth of a central bank that is able to scientifically control the supply of fiat money independently of politics. In fact, he explodes this myth by pointing to the Fed under Chairmans Martin, Burns, Volcker, and Bernanke all of whose polices were powerfully shaped by the interests of the Presidents they served under. O’Drisoll concludes: “A central bank is necessary as long as an economy is wedded to a fiat currency. And it may at times behave independently—but not in the face of large-scale budget deficits, as we have today.”
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Last Wednesday (Dec 26, 2012), I posted the following comment on The Amazingly Popular Bush Tax Cuts by Randall Holcombe:
No original expiration date, no current ‘crisis’ and no or little impact on policy and regime uncertainty attributed to this part of tax code which has hampered economic planning since the shift in Congress to Dems in 2006.
“Real Housewives of the Beltway: How the script for the fiscal cliff melodrama was written” in the Wall Street Journal (Sat. December 29, 2012) provides a more comprehensive discussion of how this on-going “melodrama was written.” The first item they mention is the one I highlighted above:
The first mistake goes back to the original compromises to pass the Bush tax cuts of 2001 and 2003. Those lower tax rates are expiring now because they weren’t made permanent then.
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But for the Journal the primary culprit underpinning these continuing bad policy choices is the ‘vampire’ like Keynesian influence on “mostly Democrats but increasingly many Republican and conservative intellectuals─who think that growth derives from government spending … .” Though, as argued by Block and Barnett (“Involuntary Unemployment,” Dialogue, Vol. 1, 2008, pp. 10-22), “one would have thought that Keynesianism would have been stopped dead in its tracks by the phenomenon of stagflation.” Too bad the stake was never completely drive through the heart of the vampire. Thus the vampire lives and as a result of this underlying fallacious view of how the economy operates, The Journal argues: ( Continue… )
The war on cash in Sweden may be stalling. The anti-cash movement has been vigorously promoted by major Swedish commercial banks as well as the Riksbank, the Swedish central bank. In fact, for three of the four major Swedish banks combined, 530 of their 780 office no longer accept or pay out cash. In the case of the Nordea Bank, 200 of its 300 branches are now cashless, and three-quarters of Swedbank’s branches no longer handle cash. As Peter Borsos, a spokesman for Swedbank, freely admits, his bank is working “actively to reduce the [amount] of cash in society.” The reasons for this push toward a cashless society, of course, have nothing to do with pumping up earnings from bank card fees or, more important, freeing fractional-reserve banks from the constraints of bank runs. No, according to Borsos, the reasons are the environment, cost, and security: ”We ourselves emit 700 tons of carbon dioxide by cash transport. It costs society 11 billion per year. And cash helps robberies everywhere.” Hans Jacobson, head of Nordea Bank, argues similarly: “Our mission is to make people understand the point of cards, cards are more secure than cash.”
Fortunately, it seems that the Swedish people are not falling for the anti-cash propaganda spewed by private bankers and Riksbank officials and are resisting the trend toward a cashless economy. It is reported that last year the value of cash transactions in Sweden were 99 billion krona which represented only a marginal decrease from ten years ago. And small shops continue to do one-third to one-half of their business in cash. Furthermore a study of bank customers satisfaction released by the Swedish Quality Index in October 2012, indicated that the satisfaction index was pulled down among customers of Swedbank, Nordea and SEB by their policy of eliminating cash transactions at their bank branches. Even more heartening is the fact that Handelsbanken, the largest bank in Sweden, is committed to serving consumers who demand cash. As Kai Jokitulppo, head of private services at Handelsbanken, puts it:
“As long as we know that our customers are asking for cash, it is important that we as a bank [are] providing it. . . . We see places where other banks are taking other decisions, we get customers from them and positive response.”
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Fewer then 10 of Handelsbanken’s 461 branches currently do not handle cash and the bank’s goal is to have cash in every branch by the first quarter of 2013.
HT to Per Bylund.
Austrian business cycle theory explains the general pattern of the boom-bust cycle — credit expansion, lowered interest rates, malinvestment, crash, liquidation — but the particulars differ in each historical case. (Austrians sometimes distinguish “typical” from “unique” features of each cycle.) To explain particular episodes, we appeal to specific technological, regulatory, political, legal, or other conditions. For example, in the 1990s, much of the malinvestment was channeled into the IT sector, where uncertainty driven by rapid technological change made entrepreneurs particularly susceptible to forecasting errors. In the 2000s, of course, malinvestment appeared largely in real estate, the result of government programs designed to relax underwriting standards and otherwise increase investment in particularly risky real-estate assets. In other words, ABCT tells us to look for malinvestment during the boom, but not where that malinvestment will show up.
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Regarding the latter example, however, there has been a persistent dispute among mainstream economists about the role of government housing policy, particularly the Community Reinvestment Act which was used, in the 1990s, to make banks increase their lending to particular low-income neighborhoods. Paul Krugman asserts, for example, that the “Community Reinvestment Act of 1977 was irrelevant to the subprime boom.” Actually, no. A new NBER paper (gated) on the CRA is causing quite a stir. Authored by four economists from NYU, MIT, Northwestern, and Chicago, the paper is the first to use instrumental-variables regression to distinguish changes in bank lending caused by the CRA from changes that would likely have happened anyway. (The authors use the timing of loan decisions relative to the dates of CRA audits to identify the effect of the CRA on lending.) The results suggest that CRA enforcement did, contra Krugman, lead banks to make substantially riskier loans than otherwise. Raghu Rajan puts it in a very Austrian-sounding way: ( Continue… )
Emory University in Atlanta Georgia has stirred up student and faculty protests with its plan to cut revenue losing academic programs. The plan includes suspending admission to its Graduate Institute of Liberal Arts and to graduate programs in Spanish and economics. Mothballing graduate programs is a magnificent development for a number of reasons and we can only hope that it signals the beginning of a trend among cash-strapped universities.
Graduate programs are enormously costly to maintain because graduate students receive huge subsidies in the form of a tuition waiver plus graduate or teaching assistantships that pay stipends that reportedly can run as high as $30,000 per year. In most cases, the taxpayer is footing a large part of the bill. Not only are most large research universities with graduate programs state-owned institutions, but the Federal government also subsidizes low cost loans to graduate students and bestows huge grants on faculty at research universities that are used to hire graduate assistants. Not surprisingly this massive government subsidy leads to artificially prolonged stays in graduate school, which cause an enormous misallocation of resources and loss of productivity in the economy as many students who will never complete their doctorates delay the start of productive careers for many years. According to a recent study, only 25 percent of Ph.D. students complete their doctorates in 5 years and only 45 percent in 7 years. Completion rates are even lower in the social sciences and the humanities.
The government subsidization of graduate education also explains why many who do complete their doctorates and have aspirations to work in higher education confront markets glutted with job seekers, especially in the humanities and social sciences. If they persist in pursuing an academic career, they then face the prospect of earning a precarious living as an “untenured” adjunct professor, hectically shuttling between teaching assignments at different universities and earning a meager living for their trouble. They, and society at large, would be better off if they had never been lured into enrolling in graduate school and had chosen a different career path, for instance, in the insurance business. ( Continue… )
Numerous studies have found that government spending multipliers have a very low value. Indeed one recent study found that in a country with characteristics like the U.S., it was significantly negative. Yet Keynesian economists are more desperate than ever to show that government spending can be effective in promoting economic recovery. Last week the Federal Reserve Bank of San Francisco released a summary of an NBERworking paper written by two of its economists. One article in the financial media called attention to the release under the screaming headline “STUDY: Every $1 Of Infrastructure Spending Boosts the Economy by $2.”
The paper in question purports to demonstrate that Federal government spending on infrastructure projects has a much higher “multiplier” effect on real income than previously thought. According to the authors of the paper, Fed economists Sylvain Leduc and Daniel Wilson:
We find that unanticipated increases in highway spending have positive but temporary effects on GSP, both in the short and medium run. . . . We also assess how much bang each additional buck of highway spending creates by calculating the multiplier, that is, the magnitude of the effect of each dollar of infrastructure spending on economic activity. We find that the multiplier is at least two. In other words, for each dollar of federal highway grants received by a state, that state’s GSP [Gross State Product] rises by at least two dollars. . . . Over a 10-year horizon, our results imply an average highway grants multiplier of about two.
Needless to say the study has numerous flaws. It narrowly focuses on highway spending funded by Federal grants. Actually, its focus is even more narrow because the spending variable is “unanticipated” increases in highway spending, not highway spending itself. The authors seek to capture spending “shocks,” defined as “unanticipated events that affect economic activity,” because only spending that is not anticipated and adjusted to in advance can reveal the full impact of spending on the economy. And indeed LeDuc and Wilson assure us that they carefully construct a “variable” according to the latest methodology for capturing errors in forecasting each state’s future highway grants. This statistical construction is supposed to be a proxy for changes in volatile and subjective expectations about the political, economic, and financial variables that affect actual highway outlays. Forgive my deep skepticism, but I don’t think so. ( Continue… )
This year’s Nobel-ish prize in economics goes to Alvin Roth and Lloyd Shapley for research on “matching methods” and the resulting application to “market design.” Briefly, this work deals with allocating resources in the absence of money and prices. Shapley applied noncooperative game theory to study the properties of different matching rules, and Roth studied various allocation rules to encourage “efficient” matching of actors or traders without using prices.
A good nontechnical summary of Roth’s work appears in a 2009 Harvard Business Review article. I discussed some of the issues in a 2007 blog post. There I noted that while the very idea of “market design” appears oxymoronic to those steeped in Menger, Mises, and Hayek, most of the work by Roth and colleagues deals with regulated markets, and can hence be interpreted as research in regulatory reform. More generally, none of this work deals with “designing markets” in the broad sense, but rather with narrow, technical issues in administrative design. (E.g., who gets to propose the first trade? How many potential trades are considered in each round? Etc.) As one friend of mine remarked, “this is one of the most boring prizes yet. At best it is a prize for some no doubt useful ideas in some small contexts of effecting coordination, but the real coordinating marvel is the market.”
Note that the study of resource allocation without money and prices is part of praxeology, but not what Mises called catallactics, the study of market exchange with monetary calculation. Mises includes the economic analysis of socialism and war, and parts of Crusoe economics, as within the non-catallactic parts of praxeology, but there has been relatively little work by Austrians in this area. Some of my own research on resource allocation within the firm could fit, as does Mises’s analysis of bureaucracy. ( Continue… )
Poland’s foreign minister told EU officials his country will join the euro zone “when you have resolved your problems and when we can say to our people ‘we can now safely join.’ ”
On a related note, London Mayor Boris Johnson urges Croats not to put their heads “in the Brussels noose” in his Telegraph column yesterday. If Croatia follows through with its plan to become the 28th EU member next July 1, writes Johnson, it will have escaped one doomed federal structure (in the 1990s) only to attach itself to another–without even the benefit of an opt-out clause.
It goes without saying that the EU needs Croatia much more than the reverse, if only to counter the economic and political backlash that will accompany the Grexit, for which firms are preparing now. The Croats shouldn’t join as it’s hard to explain why Croatia’s economic performance since independence can be improved upon by doing so–but if they must, they are beyond foolish not to use their tremendous bargaining power to require better terms.
The economic integration of Europe, and the peace that trade begets, does not require lost sovereignty. Rather, it requires trade which nation-states can only hinder. It amazes one to think about how much more wealth and, by extension, charity there would be in Europe today if so many billions of euros were not forcibly transferred to the super-bureaucracy in Belgium. Let’s hope Poland’s foreign minister is up for a long wait.
To honor Julia Child on her 100th birthday, Lynne Kiesling writes a nice post combining three of my favorite things: cooking, entrepreneurship theory, and Austrian economics. Good cooking is about the combination of heterogeneous resources, it requires experimentation and creativity, and it either works or it doesn’t. Most important:
A system that will yield the most valuable and pleasing combinations of entrepreneurial economic or cooking activities will have low entry barriers (anyone can try to cook!) and a robust feedback-based system of error correction. Low entry barriers facilitate creativity in discovering new useful products from the raw elements, as well as enabling new value creation when some of those raw elements change. Error correction, whether a “yuck, that’s gross!” at home or a lack of profits due to low repeat business at a restaurant, is most effective and valuable when there are feedback loops that can inform the cook-producer about the value that the consumer did or did not get from the dish.
This emphasis on error correction highlights one of my differences with Kirzner’s approach to entrepreneurship. In Kirzner’s system, which emphasizes entrepreneurship as a coordinating agency, the entrepreneur is modeled as “piercing the fog” of uncertainty — hence the familiar metaphor of entrepreneurship as the discovery of preexisting profit opportunities. My approach focuses on action, not discovery, and gives a larger role to uncertainty. What generates coordination, in this approach, is the entrepreneurial selection process, not the “correctness” of entrepreneurial decisions.
Incidentally, Saras Sarasvathy often uses cooking to illustrate her “effectual” approach to entrepreneurial decision-making (i.e., cooks don’t always follow a recipe to produce a known dish, but use the ingredients they have in a sequential, experimental process). And for more on food, see here and here.
The British Olympic organizers restricted ticket purchases, rewarded corporate purchases but not corporate use, imposed price controls on tickets available to the public and state violence against the resulting scalpers (touts) — and are distraught and surprised over the empty seats that characterize so many of the Olympic events so far. To reduce the embarrassment and sense of scandal, organizers have carted in British troops–dressed in their camo!–to fill seats at gymnastics events, while other easily manipulated, low-time-cost groups on the government’s payroll are also being bussed in to other sparsely-attended venues.
Meanwhile, many thousands willing to pay market prices to attend Olympic events are told to bugger off.
The Olympics are essentially mercantile events in which planning takes place outside of market forces so as to achieve outcomes preferred not by consumers but by states. (Peter Hitchens argues here that this trend started with the 1936 Olympics in Berlin when Hitler and Goebbels transformed them into “grandiose and torch-lit” spectacles.) Regardless, the events in London are demonstrating once again what an LSE economist in the 1930s said about economics–that its “curious task” was “to demonstrate to men how little they know about what they imagine they can design.” Why did Sebastian Coe and his team think they could effect a better outcome than what would result from the price system? These are practical men, but even Keynes might admit that they are probably slaves of some defunct and incorrect economist.
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