PIMCO
bond manager Paul McCulley's recent commentary, A
Kind Word for the Austrian School, contrasts the Austrian and Keynesian
views on macro-economics. After reading it several times, I am still slightly
puzzled about whether McCulley understands, or accurately represents, the
Austrian view.
McCulley writes:
And the concept of a "neutral" real rate is a
very Austrian notion: there exists some unobservable interest rate (called
the "natural" rate by Austrians) that perfectly matches the time
preference of lenders and borrowers and in the absence of fiat currencies,
free markets would find this rate (as if by Adam Smith’s invisible
hand), bringing about just the right amount of investment and savings.
In turn, Austrians argue
that if fiat currencies do exist and if policymakers peg rates below the
natural rate, there will be an excess of investment relative to that level
which would generate returns consistent with the natural cost of borrowing,
producing an investment bubble, which will be revealed when policymakers lift
rates to or above the "natural" rate, generating an investment
bust.
This is where the Austrian School is in direct opposition to the Keynesian School. For Keynes, investment was not
a function of savings, but rather savings was a function of investment, which
drives income, from which savings flow. Yes, after the fact, savings and
investment must, as an accounting matter, equal each other.
But there was no a
priori reason, Keynes argued, that savings and investment would ex post equal
each other at full employment. For Keynes, what mattered was ex ante investment
desires, which were driven by the state of confidence in long-term return
expectations, summarized as animal spirits.
Thus, for Keynes there
was no magical natural – or neutral – rate of interest. Indeed,
Keynes actually put more emphasis on the role of stock prices than interest
rates in eliciting the ex ante desire to invest. Yes, the great James Tobin
found his Q in Chapter 12 of Keynes’ General Theory!
Which brings us back to
the ironic crossover between the Keynesian School and the Austrian School: if investment is a function of animal spirits and if animal spirits get their
mojo from asset prices, then boom and bust in investment is endemic to the
capitalistic system. That doesn’t mean that it’s not the best
system ever devised for allocating resources. It is. But it is also
inherently given to cycles of euphoria followed by doom.
For the Austrians, the
solution to this problem was to kill fiat money systems and in the absence of
that prescription, to resist using fiat money systems to soften periods of
busts. For Keynes, writing at a time when the Austrian "solution"
was de facto being applied, called the Great Depression, this made no sense
at all. If investment and savings were equaling each other at 25%
unemployment, then it was the duty of the sovereign to incite animal spirits
with monetary ease, while even more important, boosting public investment.
I find this passage slightly
misleading. McCulley's reading of Keynes is accurate: Keynes did believe that
boom and bust cycles were inherent in the capitalist economic system, and
that unemployment was likely to exist in the labor market even when capital
markets were in equilibrium.
Austrian economists do not deny
that boom and bust cycles are a recurring feature of the world that we live
in. The question is whether the causes are endogenous, as Keynes thought, or
exogenous, driven by central bank mis-regulation of the credit markets.
Austrians believe the latter.
McCulley is correct in
describing the Austrian solution to actual boom and bust cycles, but
not if he meant "the Austrian solution to the problem of endogenous boom
and bust cycles in the capitalist system". Since the problem of inherent
instability in a market economy does not exist in the Austrian view, no
solution is necessary. The "Keynesian problem" that McCulley refers
to in the last quoted paragraph is only a problem for those who agree with
Keynes.
I would also dispute the claim
the the "Austrian" solution was being applied during the
Depression. In particular, with regard to labor markets, there were efforts
by policy makers to prevent labor markets from clearing by keeping wages at
pre-depression levels when the money supply had collapsed significantly. The
Keynesian "solution" was to divert more real savings into wasteful
government spending, which lengthened the process of capital restructuring
that was necessary in order for labor to find employment that would reflect
actual consumer preferences and resource constraints. According to Austrian
economic historian Robert Higgs, the threat of
nationalization of the private sector depressed investment. Austrian
scholar MacKenzie discusses
the role of tarrifs and high taxes in prolonging the depression.
Later, in another passage which
again leaves me slightly puzzled, McCulley writes:
Yes, it [a low and stable CPI] can work for a time. But
precisely because it can work for a time, it sows the seeds of its own
demise. Or, as the great Hyman Minsky declared, stability is ultimately
destabilizing, because of the asset price and credit excesses that stability
begets. Put differently, stability can never be a destination, only a journey
to instability.
Keynes knew that. The
Austrians knew that. On that, they agreed. What they disagreed about was
whether instability was caused by fiat money makers holding real rates away
from the natural level. For Keynes there was no ex ante natural rate level,
only an ex ante imperative for policy-makers to pursue full employment. And
the key to that was maintaining investment – private and public. For
Keynes, there was no natural rate of interest at which that would happen,
because investment is inherently the product of animal spirits, which
fluctuate in animal-spirited ways.
What exactly did the Austrians
know? It is a standard Austrian observation that a low and stable CPI is
compatible with a high rate of bank credit expansion, so long as the credit
expansion works mostly to distort relative prices within capital markets and
between capital goods and consumption goods and not to raise the prices of
consumption goods. So McCulley would be correct if he if his point is that a
period of expansion with a low CPI can eventually result in a cycle bust. To
"stability...is only a journey to instability...the Austrians knew
that" is confusing at best. What Austrians knew is that phony stability
-- an artifact of the way that the CPI is measured -- can mask real
instability.
McCulley's discussion leaves out
the possibility of true stability, which occurs under a sound monetary
system, when the interest rate is set by the supply and demand for real
savings. In this type of stability, economic growth only to the extent that
there are real savings available to fund it. This mode of economic growth
does not contain the seeds of its own destruction.
In the end, the point that
McCulley is making is that the Austrians provide a bit of wisdom in advising
the central bank not to ignore booms in asset prices. His conclusion:
Yes, I am a Keynesian. But more precisely, I’m a
Keynesian wearing Minsky clothing, and doffing Austrian shoes. In the
fullness of time, I expect Chairman Bernanke, a brilliant Keynesian, to
rediscover that the Austrians were not all wet in their diagnosis of the
potential for maldistribution of investment, even though they were soaking
wet about what to do about it. The Austrians said let the asset price and
credit excesses purge themselves. A much better way, I believe, is to lean
against the excesses preemptively, using all available tools, including
regulatory tools.
Yes, inflation targeting
is fine. Myopic inflation targeting is not. Asset prices matter, and not just
in the context of their influence on aggregate demand relative to aggregate
supply and, thus, inflation. Asset prices matter in their own right, because
wild swings in asset prices, even in the context of "stable" goods
and services inflation, are a source of both volatility and maldistribution
in investment.
Are we making progress at
getting out accurate understanding of the Austrian school? You decide.
Robert Blumen
Robert Blumen is an independent
software developer based in San Francisco, California
|