Austrian Economics and Other Heterodoxical Schools

The director of LvMIC asked me to write a post about a new article in The Economist:

The Economist is out with a new piece highlighting a few schools of economic thought that are putting pressure on what has been considered the conventional view among the profession over the past few decades.  Entitled, “Heterodox Economics: Marginal Revolutionaries,’ the piece summarizes these new schools as follows:

Warren Mosler, an innovative carmaker, a successful bond-investor and an idiosyncratic economist, moved to St Croix in 2003 to take advantage of a hospitable tax code and clement weather. From his perch on America’s periphery, Mr Mosler champions a doctrine on the edge of economics: neo-chartalism, sometimes called “Modern Monetary Theory”. The neo-chartalists believe that because paper currency is a creature of the state, governments enjoy more financial freedom than they recognise. The fiscal authorities are free to spend whatever is required to revive their economies and restore employment. They can spend without first collecting taxes; they can borrow without fear of default. Budget-makers need not cower before the bond-market vigilantes. In fact, they need not bother with bond markets at all.

The neo-chartalists are not the only people telling governments mired in the aftermath of the global financial crisis that they could make things better if they would shed old inhibitions. “Market monetarists” favour more audacity in the monetary realm. Tight money caused America’s Great Recession, they argue, and easy money can end it. They do not think the federal government can or should rescue the economy, because they believe the Federal Reserve can.

The “Austrian” school of economics, which traces its roots to 19th-century Vienna, is more sternly pre-Freudian: more inhibition, not less, is its prescription. Its adherents believe that part of the economy’s suffering is necessary, an inevitable consequence of past excesses. They do not think the Federal Reserve can rescue the economy. They seek instead to rescue the economy from the Fed.

The article does a rather lacking job of summarizing the Austrian school (no mention of praxeology or individual methodology?) and dedicates more print to Scott Sumner and Warren Mosler.  However, it’s always nice to see the Ludwig von Mises Institute receiving some mainstream attention:

The resurgence of Austrian analysis is not merely a web-based phenomenon. In 1981 Margit von Mises approved the establishment of an institute in the name of her late husband, Ludwig von Mises, one of the giants of the Austrian tradition of economic thinking. The Mises Institute set up shop at Auburn University in Alabama, attracted by a couple of “Austrian-friendly” faculty members and a timber owner willing to donate money to the cause. From early days in the shadow of the football stands, the institute now boasts its own amphitheatre, conservatory, recording studio and library. At one of the institute’s soirées, accompanied by a recital on its Bösendorfer piano, Vienna may not seem so very far away. Yet the institute’s impressive web presence, with ever more signing up for its online classes, makes its ideas, if not its ambience, available to all.

Despite its emphasis on MMT and market monetarism, the article brings up an important point.  Mainstream Keynesians and monetarists missed the financial crisis with flying colors.  This was a clear signal that a more developed theory needed to be heard and vetted which described why the crisis occurred and what the proper solution was.  In a guest post I had over at the Austrian economist Robert P. Murphy’s blog, I praised what I termed the financial/economic punkosphere:

This is precisely what encapsulates the financial/economic punkosphere.  It is composed of a minority of like-minded individuals spontaneously coming together who reject conventional wisdom and aren’t beholden to academic tenure.  In a global economic system defined by the collusion of government and large financial institutions, these bloggers and commentors try to make sense of the world while calling out idiocy whenever they deem fit.  Keep in mind; the label “punk” is used as a term of endearment for its rebellious connotation and not an insult.In this spirit, I praise what has become the financial/economic punkosphere that consistently challenges the establishment.  The internet has done wonders in the decentralization of information and knowledge.  No longer do ivory tower academics hold all the sway when it comes to economics.  Thanks to this new outlet of blogs, the Federal Reserve has never faced such scrutiny by the public in its almost century-long existence.

While the Austrian school has seen a resurgence thanks to the financial crisis, other schools such as Modern Monetary Theory have gained prominence as well.  What sets the above mentioned schools apart from the Austrian view is an almost fanatical belief in the sanctity of central banking.  Both MMT and market monetarism advocate for more aggressive monetary easing as a cure for the current downturn.  Economist Scott Sumner, who popularized National Gross Domestic Product targeting, has been drawing a lot of attention lately from the likes of Paul Krugman and former Obama economic adviser Christina Romer.  His rise to fame as a leading market monetarist is documented within The Economist article.  I have already covered the issues associated with the “targeting NGDP” in my American Thinker piece entitled “The Problem with the Fed’s Targeting.”

The idea behind targeting NGDP assumes that Bernanke, after failing to boost the economy for over three years, can somehow hit a target that’s dictated by the actions of billions acting homogenously.  Putting money in the hands of banks and individuals doesn’t guarantee that said money is spent in a fashion to boost NGDP.  As financial blogger Mike “Mish” Shedlock puts it, “[f]or starters the Fed cannot spend money, it can only lend it. Thus the Fed has at best an indirect affect on GDP.”  The real danger lies in the overshooting of a target which can lead to out-of-control inflation.

In the end, businessmen and entrepreneurs don’t keep their eyes on potential nominal gross domestic product.  The owner of my preferred local pizza shop isn’t scanning national economic statistics to see if NGDP has a possibility of hitting 5% a year from now.  He monitors a number of factors including input and output prices, tax rates, regulations, and profitability potential in order to decide if he should expand business or pack up shop.

Market monetarism buys into the same myth many Keynesians do: that the Great Depression was caused in part due to tight monetary policy from the Federal Reserve.  But as Gary North has pointed out, the monetary base did not shrink during the first few years of the crisis and in fact increased after the advent of the FDIC:

Money supply fell due to bank closings, but the Fed kept the monetary base stable and then went about increasing it.  After 1934, the printing press really began to prove its worth.  Market monetarists hardly mention this historical occurrence.  The cheap money narrative is far too appealing for their policy prescriptions.  The same goes for the erroneous belief that the Federal Reserve, with its inflationary practice from 1927-1929, didn’t cause the Depression.  Central bank apologists were fooled by the stable price level during that time period despite the overwhelming evidence of monetary prime pumping occurring at the time.

In short, the market monetarism solution for any economic problem is inflation- plain and simple.  The irony being that Modern Monetary Theory holds the same views.  While market monetarism is wary of government spending as an effective remedy for downturns, MMT is a no holds bar endorsement of the type of print-and-spending tactics that lead to bubbles and bursts.  According to MMTers, currency gains its value with the direct threat of taxation imposed via the government.  MMT giant Warren Mosler describes this concept in this eerie thought experiment:

The following is not merely a theoretical concept. It’s exactly what happened in Africa in the 1800’s, when the British established colonies there to grow crops. The British offered jobs to the local population, but none of them were interested in earning British coins. So the British placed a “hut tax” on all of their dwellings, payable only in British coins. Suddenly, the area was “monetized,” as everyone now needed British coins, and the local population started offering things for sale, as well as their labor, to get the needed coins. The British could then hire them and pay them in British coins to work the fields and grow their crops.

Simply incredible.  The MMTers believe that in order for private savings to occur, the government must spend first.  Deficits then never matter in terms of borrowing costs since the printing press is always available.  Inflation, according to the MMT doctrine, can be controlled through taxation, no matter how high, to suck money out of the economy should things become overheated.

There are a number of fallacies in these concepts.  While government has monopolized currency creation, currency was originally a product of the free market.  There is no requirement outside the state’s infinite lust for control that currency creation can’t be left to the private sector. While inflation can in theory be controlled by taxation, it can’t be guaranteed that it would be an effective means to cool down accelerating prices.  The epistemological problems such as how central planners know the correct tax rate or when to even implement it is also never answered by MMTers.
 
In short, both the MMT school and market monetarism rely heavily on the belief that central bankers are capable of fine tuning the economy to their liking.  They ignore the Cantillion effects new money creates when making its way through the economy.  Asset bubbles, inflation, and malinvestments are of no concern to either views.  The Austrians on the other hand recognize the fallacy of central planning and have a developed theory of the business cycle.  They saw the financial crisis coming from miles away unlike one leading MMT proponent.

Though its a wonderful development that mainstream economics is being challenged, Modern Monetary Theory and market monetarism hold very few differences from Keynesiansim.  All three advocate for central banking as a remedy for crisis.  None have an adequate theory on booms and busts outside of “print more money.”  They will therefore never hold a candle to the Austrian school and its insights.