I left off in the last article mentioning a tidbit about the RBCT (Real Business Cycle Theory) and its connection to the ABCT (Austrian Business Cycle Theory). Surely, the “Real” part of RBCT sounds precocious, until you understand that it is merely meant to explicate that the business cycles it attempts to describe are caused by “real,” i.e. material, changes in the structure of production; these can be caused by technological advancements, governmental policy changes, and the like. Not many Austrians would deny that when new technology arises, there is going to be capital restructuring, which may or may not cause some temporary setbacks in the total output of goods in a given economy. For example, the invention of the tractor displaced many farmworkers and caused them to have to move into other areas in farming, or other industries entirely, or drop out of the workforce for whatever reason. Even then, it may be argued that total output still rose, though individual incomes for some may have fallen for some time, but in the long run, the total amount of farms’ output increased thanks to the improvements made in farming technology. Similarly, there is even more doubtfully even a single Austrian that denies that political action can change the landscape of the market. A politician can decide to ban dogs, and then a whole new capital structure involving illegal dog-breeding will likely emerge. Regardless, these exemplify “real shocks” to the system’s productivity; more or less farm products of a given variety may have been produced as compared to before due to the new technology or laws, workers may have been displaced, resources such as fuel may be diverted from other lines of production into the construction and maintenance of the newly invented forms of capital, dog food may itself move “underground,” etc. If you’d like an Austrian approach to this, I would recommend my article “Ludwig Lachmann’s Psychedelic Solitaire,” as well as pretty much anything written by Lachmann on capital theory. Though, to be sure, he generally holds lawmakers as part of a cetus paribus static factor and monetary theory as dynamic, as he really did not care much for politics. As an interesting aside, the public-choice school has made some incredibly advances in the latter area that are surely worth investigating (and have been by many of the aforementioned varieties of macroeconomists).
Garrison talks about how the RBCT is an actually-occurring phenomena. Instead of presenting an except from one of his books, I will instead use an excerpt from one of his videos, an interview with Jeffrey Tucker, to illustrate how unsustainable policy-induced booms can “piggyback” on top of real booms, or booms caused by political instead of monetary policy. Here, he compares the technological boom of the twenties made problematic by artificially-low interest rates with the housing “boom” created by politicians and amplified by credit expansion, which Tucker readily identifies as an expanded view of the RBCT:
The fact that “exogenous shocks” to the system can cause instability and macroeconomic problems is heartily accepted, not only by New Classicists, but also Austrians. Here we have two Austrians talking about exogenous shocks to the economy(!) However, they take it a step further and mention that these shocks were exacerbated by credit expansion. Tech boom beginning in the early 1920’s turned bursting tech-and-banking bubble in the 1930’s, tech boom beginning in the early 1990’s turned bursting tech-and-stocks bubble in the late 1990’s, housing “boom” created by politicians in the early 2000’s turned housing-and-banking bubble bursting starting in 2007, all perfect examples of what New Classicists would call “exogenous shocks” in one form or another, made vastly more detrimental by irresponsible expansion of the supplies of money and credit, something Austrians agree with.
However, RBCT advocates (generally New Classicists and new-school monetarists, who are quite similar) maintain such an aggregative structure as to completely ignore perversities in the monetary system. They don’t see the fake, piggybacking growth, from the real, emergent, Hayekian spontaneous order that drives market innovation. Of course one can claim that all the big shocks to the system come from “real” factors when one counts money as neutral, predictable policies as irrelevant to decision-making, and lumps all data together in such a way that allows one to “empirically” show that all nominal (“inflation-adjusted,” however attempted) growth comes from real growth. No wonder the vast majority of RBCT advocates admit that technology or unexpected policy decisions can cause shocks to the economy while, at the same time, deny that there can be a compounding of problems that turns the normal-but-irregular changes in an economy into the abnormal, unsustainable growth patterns in the capital structure. If you ignore all capital theory, or at least cut any ties to monetary theory, of course you can claim that the ABCT is incorrect, because interest rates (which help coordinate intertemporal resource allocation) make no difference. Indeed, most economists of the EMH/rational-expectations/etc. vein see no use for incorporating the variables of time and Wicksellian interest theories into their models.
Now let me ask you this question: if interest rates do nothing to alter the allocation of resources in the present and throughout time, what is the point of implementing such policies in the first place? Many New Classicists, and ostensibly all New Keynesians advocate manipulating the money supply to juice up the economy, or at least prevent collapse. However, if interest rates don’t affect markets, because money is “neutral” and “endogenous” to the rest of the system, what could such a tactic possibly do to influence the economy in any useful way? Keep in mind that this is perhaps doing some violence to New Classicists/New Keynesians/new-school monetarists, because it is arguing against the policies they advocate by using their descriptive theory, rather than arguing purely against their descriptive theory, but it does help illustrate how they think markets are efficient but not necessarily a proper (intertemporal) allocator of resources.
Anyway, let’s leave that one alone for a moment and return to the link between Garrison and Schumpeter. Schumpeter saw economic history as a series of technology shocks that permanently alter markets (we’ll leave aside his eschatological views here, for sake of clarity). Surely, technology advances. One might debate whether these innovations cluster up like the image shown at the top, though I present that one for an understanding of Schumpeter’s views of the business cycle, not necessarily as a positive statement. One might also use the following image as an example, wherein the second dimension has been levelled out:
Here we might mention that Schumpeter saw business cycles as having short-term fluctiations, mid-term fluctiations, and long-term fluctiations, here not depicted, wherein there may be as many as five or even ten various cycles at work at any given time. The images posted to represent thus far Schumpeter’s view of the business cycle are meant to depict his view of the longest of the long runs in the various business cycles. Many Austrians would agree that at any given point in time, there are perhaps several various cycles at work. Many others might dispute the accuracy of this (Lachmann’s kaleidism) and still other Austrians would object to such an assertion on purely epistemological grounds: how do we know what these cycles are, when they occur, why they occur, where they occur in which variables we (can) observe, and so on, and so forth?
Here I’ll jump in and tie back the current digression to the link between old-school monetarists of the Friedman variety with Austrians. Austrians and Chicagoans agree that stable growth with as little inflation as possible is the best realizable situation for a given economy. To be fair, Friedman was essentially a harm-reduction expert; he did not endorse the Federal Reserve’s existence, in fact, he opposed it. He merely tried to make it do as little harm as possible. The Austrians’ epistemological and catallactic objection to Chicagoan-styled policies rests on this simple premise: the mere existence of a central bank warps the rate and stability of the growth of an economy, and thus, attempts to keep the economy from falling into collapse (as opposed to the more-extreme Keynesian countercyclical policies) are themselves embattled by the fact that the central bank is itself a major, if not the major, source of instability in a fiat system. It is very akin to, as mentioned in the first article of the series, the measuring tool changing the outcomes of the quantum phenomenon being measured. Here we might inject another graphical representation:
Forgive the stylization (or lack thereof), as this is merely a quick sketch made exclusively to illustrate my point. Note the similarity in the Austrian view of an economy unaltered by central banking, with a monetarist view of an economy prevented from collapse by means of central banking, as compared to a central bank that just doesn’t care about, or know how to prevent, deflationary depression and collapse. This is where Austrians, as mentioned, point out the problem of simultaneous central banking and collapse-prevention in making a case for central banking: the growth pattern and trajectory has already been confused by the mere presence of the tool of centrally-controlled fiat currency. Of course, many monetarists in the Friedmanite vein advocate the abolition of the Fed, as well as in other market-coordination-oriented schools of economics, but the point remains.
I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm.
-Milton Friedman, in an interview with the Hoover Institute
This is precisely what the graphical representation above is intended to explicate. Chicagoans believe in the free market, they just don’t want to see it destroyed by antimarket forces; most prominently, a collapse in the money supply. Conversely, Austrians argue that such total and catastrophic collapses can only be brought about by central banking in the first place. After all, Friedman only cared about solutions for a crash, while Austrians also inquire as to the ultimate causes of such deflationary collapses. Indeed, to Austrians, the “bottom” would not “drop out of the world” if it weren’t held up on stilts made of mile-high toothpicks and silly putty. Indeed, Chicagoans in the Friedman vein, including Friedman himself, agree. Friedman argued that before central banking, crises were usually well-managed by markets on their own, but now that we have a central bank controlling monetary policy, instead of employing discretionary, countercyclical, or no monetary policy policy at all, we should keep the central bank from creating collapses.
Really, the only difference here is that Chicagoans think that deflation happens under a central bank that has created a tendency for it by its mere existence, and then falls asleep at the wheel on the eve of a collapse. Austrians think that central banks first ratchet up economies by getting drunk at the wheel, then inevitably crash, and harm themselves, whether they drink on their way to the hospital and worsen things or not. Use all the mile-high toothpicks and silly putty you want to hold up your fancy Sisyphean skyscraper, argue the Austrians, but that thing is eventually coming down whether you like it or not.
Accusing Austrians of wanting to let the “bottom drop out of the world” is akin to Jim, opposed to heroin use, accusing his friend Bob of wanting to harm his addicted mother, because Bob advocates that she quit cold-turkey; meanwhile, every time she tries to wean off of it, things only get worse right after. Is Jim really much more of a saint for saying she should try to wean off, once again (or at least, reduce her usage step-by-step)? Maybe, in that sense, Rothbard wanted the “bottom to drop out of the world,” though it is very doubtful we would have returned to the Dark Ages had the Fed been Austrian in the 1930’s, as surely most would agree.
To go further with this analogy: quitting heroin can’t kill you, but an overdose certainly can. Let us do some justice to Friedman by letting him speak for himself, though:
That should be enough Friedman for now, as we will return to him later. At this point I’d like to emphasize one of the many connections between Schumpeter and Lachmann: the idea of “creative destruction.” Old capital structures constantly give way to new ones, and sometimes there are leaps in technology that can be seen as “technology shocks” inherent to the dynamic and ever-changing kaleidic nature of the market. Schumpeter and Lachmann both argued that inherent to the nature of capitalism is the revealing, and even invention, of new demand for new products, springing forth from the entrepreneurial function in the marketplace. Schumpeter treated the entrepreneur as a “class,” like a Marxist might treat “capitalists” and “workers,” but Lachmann aptly posited that all people fulfill an entrepreneurial role, just to a larger or smaller degree. In a way, Mises’ “praxeology,” the view that all intentional action attempts to coordinate means to ends, makes it seem that the entrepreneurial process is inherent to all actions people mean to take (excluding things, of course, like stubbing a toe or sneezing).
To return to the main point, Schumpeter’s “waves of innovation” that he saw as persistent throughout time, as the longest-run of cycles in the capitalist system, can be seen as an expanded and matured form of the RBCT. It is questionable whether these periods are slowly becoming faster and faster because of some deterministic, almost Hegelian/Heideggerian view of the progress of humanity (ew), especially because human action is indeterminate. Marx’s “crises of capitalism” seem ridiculous and laughably archaic as we move forward in history (as do most hermeneutician’s theories) when one can much more easily see that the technological advances he feared increase our quality of life, while the political encroachments he advocated plainly come as a great detriment. However, it seems fair to say that the RBCT could be seen as (as aptly put in another blog) a “juvenile” form of Schumpeter’s clustered-innovation theory of business cycles, and it seems equally reasonable to posit that the RBCT perhaps could find a home with Austrians instead of merely certain varieties of neoclassical economists; just as it was discussed that many monetarist theories of deflationary recession, depression, and collapse could, as some already do, find a comfortable home in the school of Menger and Mises. Schocks to the system can come from anywhere, but you have to analyze the consistent parts of the system to to understand the consistent shocks to it. This is where Schumpeter, Austrians, and Chicagoans agree.
This is, of course, to be continued; good luck with your endeavors in the meantime.