At the end of part one I mentioned Friedman’s fears of deflation, which I said were a natural consequence of his view that depressions stem from the nature of money itself.
Friedman basically said that we should keep the nominal interest rate at zero and shoot for consistent and low inflation each year (around 3% and calculated by a computer) to keep prices flat. Think of MV=PQ. Friedman didn’t want political hacks screwing around with the money supply; he said this inevitably lead to inflation at some point, likely sooner rather than later (Austrians agree) and that counter-cyclical (e.g. Keynesian) stabilization policy would just make the business cycles more frequent and cause excess inflation with no benefit in the long term except moving the short-run Phillips curve more towards the long-run Phil curve, where there is no tradeoff between inflation and employment, just more or less inflation (Austrians again agree). Austrians even articulate this same idea themselves, just using a different set of premises (though with a great deal many in common, especially in micro).
Austrians generally don’t deny the truth of MV=PQ; it is basically an accounting tautology. The Viennese and Chicagoans merely differ in that one thinks no system of centralized system of moneyprinting is sustainable, robotic or human. There is, unsurprisingly, a multiaxial spectrum of Austrians in which some would prefer only commodities and warehouse receipts (100% gold, enforced somehow or not), others “free banking” (Selgin, White, etc), and others government (rare but extant, Hayek once saw them as a necessary inevitability); there are Austrians like Horwitz (an economist that actually shares most of Garrison’s views, just not here) that actually would prefer, say, the government covering individuals’ demands to hold money, as opposed to allowing a deflationary spiral, but would still prefer free banking to that.
Here we return to Friedman, Lachmann, and Garrison, who wield dopely similar names. The picture a few paragraphs up explains Garrison’s ideas, and implicitly, those of both Hayek and Mises as well. Mises and Hayek were not overly into the equation of exchange, though that is not to say that they denied the tautology of it. They merely argued against its effectiveness as a policy-viewing lens, and even less so, a policy-motivating device.
Friedman only looked at the total Q in PQ, not the structure thereof; the Chicago School is largely predicated upon its intentionally-simplified “stock-flow” view of capital instead of a “structure,” so of course, Friedman’s data has no way of explaining the changes “within Q,” as Garrison puts it aptly.
Austrians merely do not see it as wise to try and manipulate the interest rates and money supply to shoot for a near-constant price level; Friedman believed that it was the best thing we could do, given a government system of money. It would keep us operating damn near the production-possibilities frontier (sans taxes and such), but Austrians have many doubts as to this. Austrians, conversely, think that market competition in the money supply, or at least a government that never inflates, is a far more sustainable system, and one that keeps us from getting too far “plucked” from the PPF, whether they are into historical currency (precious metals and such), or free banking, or cryptocurrencies, etc.
If (and when) we did have deflation under such a situation: zero government interference in the market (which really means zero government) and some kind of private mechanism that people found suitable and stable as a source of money, according to most Austrians, this would not be harmful to the economy given that it is free of prior unsustainable booms, as it is the mere capital accumulation and interest thereof, along with short and inconsistent deflationary spikes, that improve the economy over time, as itself a compounding factor of an already-growing supply of goods, services, and investments that get cheaper and better-formulated as time goes on.
Friedman, of course, opposed a money supply tied down by gold, as he saw a falling P as dangerous to an economy; so it followed for him that currencies should be free-floating and untied to anything. Simultaneously, Austrians like Garrison and Mises merely posit as to the money supply that:
- Interest rates have a coordinating purpose in the market; they allocate resources intertemporally (which is better done by the market)
- Deflation caused by technological innovation and increased output is acceptable and even desirable (assuming away government intervention)
- One cannot possibly have the tools to determine the correct money supply or interest rates, and to attempt to do so will always lead to problems (though not that markets without central banks would be free of all depression)
At first glance, this seems to stand in direct contrast to Friedman’s understandings of market mechanisms and monetary matters, as well as policy advocacy. However, Friedman himself admitted that governments could never guess the right level of inflation, so his recommendation was simply that the government should shoot for a low level of inflation to keep P stable, given that we are stuck with government control of the money supply. However, keep in mind that he predicated this on the historical near-constancy of the velocity of money, as did his Chicagoan forefather, Irving Fisher. However, Friedman, unlike Fisher, opposed the Federal Reserve entirely, but said that so long as the government controls the money supply, its job should be done by a computer boldly marked “do NOT fuck with me” slathered in red with the blood of politicians. Friedman also thought, like many but not all Austrians, that we should do away with fractional-reserve banking. Conversely, many Austrians are okay with fractional reserves, and would rather see the Fed gone and banks compete with their various fractional currency, backed by some commodity (oil, gold, etc).
All of this digression aside, Friedman’s analysis of MV=PQ was not unfounded or even anti-Austrian. It is merely that his notions of Q (and M and V and P as well) were too aggregated to reveal much about the underlying economic conditions that he was trying to describe with his version of monetarism. Chicagoans are not guilty of half of the fraud and perhaps-intentional epistemic illiteracy that most neoclassical economists, even other monetarists like “market” monetarists, are. The logical positivism of the school is a great detriment to its credibility, and destroyed its predictive abilities as far as gross output/income/employment are concerned. However, Austrians would no doubt agree, for example, that *at best,* the long-run Phillips Curve is one wherein employment doesn’t go up, only inflation. Austrians even implicitly admit that the short-run Phillips Curve is correct cetus paribus, if growth was previously normal (secular) and a central bank decided to inject money into the money supply. The Chicago school is not wrongheaded (or even very wrong) in its understandings of market foundations at all; find me many Austrians that disagree with Chicagoans on micro. Austrians, best exemplified by Mises, Hayek, Lachmann, and Garrison, merely make sure to use proper epistemological foundations and thus reject static conceptions of macroeconomic states and similarly reject positivism. The Austrians see that positivism seems to work until its inherent eventual complexity changes and further complicates its own course, like the positivism in quantum mechanics, which with enough mathematics and assumptions unfazed by reality and realistic premises hit a brick wall and started the entire interpretation debate, where we have been for so many years (and will likely continue to be for a long, long time).
But for the Austrians, the great temporal disaggregators, it is recognized that with any kind of central bank, the interest rate is never at the market rate, and even when it is mimicking the actual rate (equal under other circumstances), it has already been distorted from its otherwise-paths, inexorably linked to the passage of time and expectations, by the central bank, which can never guess the right interest rate. This is perhaps only by coincidence, but especially not by design. The central bank by its mere existence has already and immediately altered the interest rate (really, the array of interest rates). Not just because of its influence on currency, but by, as Lachmann says, intentionally or unintentionally influencing expectations of the intertemporal viability of consumption and investment (though he never said it in this manner) due to government having unforeseeable future effects on individuals.
Anyway, as I mentioned, Austrians agree with Chicagoans on this, except that Austrians further posit that the short-run Phillips curve is already altered (in all likelihood for the worse) by any kind of centralized monetary authority, and in fact that the long-run Phillips Curve likely has a positive slope to it in most modern monetary incarnations, to where inflation in the long run *increases* unemployment. Austrians argue something that has incidentally seeped into many mainstream macro ideologies: the “helicopter money” idea makes for easy models but increases the implemented-policy’s encouragement of the instability of the aggregate being propped up or held down (like the Chicagoans implicitly argue of the Keynesians), along with unexplainable variability and vulnerability to wide swings viewed through the lens of simple neoclassical aggregate analysis. Monetarists, including though to a less extent the Chicagoans, and far more so the “New Classical” school of Lucas and Co., fail to understand that money is not endogenous to an economy. If it were, why would Keynesian counter-cyclical policy distort the market? If it were truly endogenous, why is it recommended that it is injected not only by an extra-market entity, but also into certain institutions, primarily banks? How could money be endogenous if it is the only thing without a market of its own, as its own price reflects the price of everything else, like a 2-dimensional shadow of a 9-dimensional constantly shape-shifting alien?
Let’s go to Lachmann on Böhm-Bawerk’s capital theory. Böhm-Bawerk essentially said that a good way to think of the capital structure (and thus stages of production) involved in the creation of some specific good, is to think of concentric rings, like those of a tree. Some are further apart, some closer together, but they do slowly gain in both width (obviously) and surface area (not-so-obviously). One represents how the product is progressing in its completion, the other by its market value (whatever that may be). Hayek’s triangle is the heir to this Austrian tradition of trying to find a simple way to represent the capital structure.
There is a certain inconsistency in Boehm-Bawerk’s theory
which is relevant to our purpose in this chapter, and to which
we must turn first. On the one hand, no other economist saw
more clearly than he the essential heterogeneity of all capital.
He speaks of capital as a ‘mass of intermediate products’ or a
‘complex of products destined for further production’. On
the other hand, his theory is essentially an attempt to reduce this
‘complex’ to a common denominator and to measure all
changes in it in the single dimension of time. It seems to us
that the root of his failure lies in this inconsistency. Starting
from a view of the capital problem which is fundamentally
sound, he failed when he tried to introduce the incongruous
element of single-dimension measurement into a theory conceived
in terms of heterogeneous products.
-ludwig lachmann, capital and its structure
Lachmann’s teacher invented the aforementioned “pedagogical tool,” as Garrison puts it (sounds kinky), so why abandon it before realizing what a great, logically sound, and empirically sturdy system of economic thought it brought forth, which took both yours and Mises’ ideas on capital seriously? Like, the triangle is a simplification dude, it’s an aggregative model, just not as aggregated as the neoclassicals’ models are. It’s merely meant to give you a visual, not inform your entire understanding of it (which could be said of many neoclassical models that align with Austrian capital theory and methodology, in fact).
Hayek’s and Böhm-Bawerk’s model of the various capital structures were actually very similar. Garrison brings up in “Austrian Macroeconomics” that really the triangle should not have a pointed end, but a cut-off one, like a trapezoid with a right angle on one side. Block levels this objection, Garrison already thought of it and incorporated it into a myriad of models in “Austrian Macroeconomics: A Diagrammatical Exposition.”. It is merely saying that total production (“Q”) is not infinitely divided , but rather a series of steps, wherein previously-existing materials are transformed using capital into an intended, final, usable good.
Another objection of Block, that one triangle cannot represent the whole structure, is merely ignoring the fact that the model is implicitly and explicitly aggregative and is merely meant to represent the combinations of all capital structures, aka “the” capital structure, in a form where all of them are put together. No Austrians are aggregating consumption like Keynes did (as a single output of an economy, as if demand for one thing were demand for any other thing), people just like the model. It should be trillions of dimensions, now two, but Austrians do try to further explicate (again, Garrison’s “Austrian Macroeconomics”) so nobody is saying that all economic knowledge = Hayek’s triangle; nor the concentric-ring model.
Lachmann’s deserved legacy is that of a genius. He was perhaps one of the best capital theorists that has ever existed, along with Mises, Böhm-Bawerk, Kirzner, and Garrison himself.
Before I go on, let me simply explain how the instability of the velocity of money screws up the Keynesian multiplier, ironic in a way, when thinking of Friedman’s occasional moneyprinter holdouts and his objections to the feasibility of Keynesian policy (of which he invoked both the consequential argument and the Public-Choice school’s argument): that inflation targeting is just as destabilizing, if not more, when compared to Keynesian countercyclical tactics. Similarly, there is little political incentive to take the medicine as exactly prescribed by the popular economists of the day, be they Keynesians of any variety (except perhaps Krugman, the exact kind of political hack Friedman wanted extinct) or Monetarists of any variety (such as Bernanke, the new-school monetarist that actually liked deficits AND printing).
The point? If money is endogenous to the market, why cannot the market successfully create and sustain money itself? It already did. In addition, if total output (“Q”) or total transactions (“T” in the MV=PT formulaton) are so important to the changes in the price level (and as Friedman admits, the capital structure itself) then why aren’t these variables worth disaggregating, whatever your take on epistemology and the philosophy of science?
To be continued. My love to all that find this stuff interesting and worth finishing; you are seated at the shining pinnacle of civilization that may someday lead us out of this hellhole that we impose upon ourselves.