Archive for January, 2012

Some Scattered Thoughts on Austrian Economics

This post isn’t really intended as a comprehensive and rigorous critique of Austrian economics – I’ll leave that to others. Instead, it’s a brief summary of why I reject Austrianism (the brand most common on the internet, anyway*).

To start, I’ll take the liberty of quoting a commenter from Brad Delong’s blog, who summed up my overall impression of Rothbardians (and to a lesser extent, Miseans) pretty nicely:

The weird thing about Austrians, it seems to me, is that they don’t like empiricism, but they don’t seem to really like deriving any conclusions that they didn’t already know from their axioms either. The rejection of empiricism, along with claims like how empirical economists can’t explain people commuting on subways, are part of Mises’s though. Also, though, look at the case of Austrian rejection of modern microeconomics on the grounds that its use of utility functions and such is inconsistent with preference rank-based description of human choice-making. Basically, that’s a rejection of the Von Neumann-Morgenstern theorem as far as I can tell. (Even though Morgenstern may have been something of an Austrian himself.) I’ve never read an Austrian actually explicitly reject the theorem, or explain his view on it in any way, but the rejection seems to be implicit in their discussions of conventional, non-Austrian micro. Why reject Von Neumann-Morgenstern? As far as I can tell, because it doesn’t fit their conception of how economic analysis should be done.

So, if you don’t look at the world empirically, and you don’t want to extend your axioms to their logical implications to conclusions that you didn’t already know, what’s left? The axioms themselves, and some thoughts hanging around their immediate vicinity. Or, to put it another way, your initial prejudices. Your thought starts where it ends, exactly where you wanted it to.

That’s what I take from Austrian economics, at least.

Internet Austrians have declared capitalism to be infallible and as such are unable to blame anything on the private sector – their conclusion is always that it’s the state’s fault. I just can’t align myself with something that seems to come to the same policy conclusions, whatever the question, whatever the situation, whatever the starting point and methodology.

Another reason I find the Austrian school to be unsatisfactory is its failure to predict and explain the 2008 crisis.

As LK has documented, Austrian claims to ‘predict’ the crisis with anything like the accuracy of Michael Hudson or Steve Keen are spurious. At best, the Austrians spotted a housing bubble, no more. Furthermore, their theory doesn’t even appear to explain the crisis particularly well, for the following reasons:

Put simply, ABCT is based on a misallocation of investment in capital goods. The imbalances created by this result in a recession, which is necessary as the capital is liquidated and put to ‘proper’ usage elsewhere. But this isn’t what happened in the financial crisis; in the crisis people were simply buying and selling the same assets to each other – housing, mortgages and their derivatives – and most of the debt taken on went into consumption. Murray Rothbard himself said:

To the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur.

Even if you accept that low interest rates caused the boom, the Austrian prescription of liquidation does not follow, as there was very little capital to ‘reallocate’. After all, derivatives are just contracts, an there is currently an undersupply of housing in many Western countries.

And, of course, sectors unrelated to the crisis have slumped at least as much as ones that were central:

On top of this, there is simply too much historical counter evidence against the idea that credit expansion/CBs cause business cycles. The Dutch Tulip Mania occurred under 100% reserve banking. The Melbourne Land Crisis occurred under a private gold standard system. The South Sea Bubble occurred without a Central Bank (The BoE did exist but was the same as the one we know and love only in name). Furthermore, the period of fewest crises was post-WW2, with universal Central Banking. This list is far, far from exhaustive.

Since this is a scattered post, I’ll also add that Austrians have completely failed to rebut Sraffa’s demolition job on Hayeks P&P (no, the response that there is schedule of interest rates does not qualify as it is simply restating the criticism), and also that their use of uncertainty appears not to recognise the term in the Knightian sense.

So, there you go. That’s why I’m not an Austrian.

*For balance, here are some good Austrian blogs: Jonathan Catalan, The Radical Subjectivist and Bob Murphy (though his Krugman obsession does get tiring after a while).

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Can Macroeconomic Policy Only Influence The Nominal? A Critique of NGDP Targeting

Update: When I am talking about nominal and real effects, insert the word ‘reliable’ as appropriate. My point was that MMs hold the distribution between RGDP/inflation to be impossible to determine, rather than that there can be no real effects.

At the centre of arguments for NGDP targeting is the implicit assumption that macroeconomic policy can only have nominal impacts. I believe this to be false.

‘Market Monetarists’ (MMs) hold that macroeconomic policy can only have nominal or ‘cash’ effects, and the effect on the actual production of goods and services is uncertain. To put it intuitively, they are saying (or believe they are saying) that the amount of cash we inject into the economy can only affect the amount of cash flowing around the economy. There are two reasons this is flawed.

Firstly, MMs use a standard AD/AS framework for their analysis. When you respond that fiscal stimulus can be spent on roads and the like, which benefits the economy in more ways than one, they suggest that you are confusing the AD side of the equation with the AS one. However, this is a problem for MMs: fiscal stimulus can simultaneously boost AD and AS (not to mention LRAS), which means that even if the CB offsets the increase in spending, fiscal policy can ensure that a higher percentage of the spending is a real increase in production. In other words, fiscal policy can impact RGDP better than monetary stimulus, at least in certain circumstances.

My second point, however, is more important and applies universally. MMs neglect of the role of the RoI in determining not only the rate but the type of macroeconomic activity that takes place (New Keynesians are also guilty of this; at least, I’ve never seen them mention it).

In a capitalist economy, the rate of interest not only determines the amount of investment, but also the nature of that investment. Here’s Adam Smith, whom I can never resist quoting on the subject:

If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten per cent, the greater part of the money which was to be lent, would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people, who will give for the use of money no more than a part of what they are likely to make by the use of it, would not venture into the competition. A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into the those which were most likely to waste and destroy it.

High interest rates mean that there is less investment and also that the investment that does take place is less sustainable. Speculative investment causes bubbles and price inflation, reducing the CB’s control over both the nominal and real economy. By keeping long term rates low, the CB is hence able to impact the real activity in the economy.

For an example, see this poorly taken photograph of long-term corporate bond yields from Geoff Tily’s excellent book Keynes Betrayed:

High interest rates are correlated with downturns, whilst steady low interest rates are correlated with the ‘Golden Age’. Rates weren’t massive in the recent crisis, though there were plenty of ‘hidden’ sources of funding such as the repo and Eurodollar markets, and expectations were not anchored downwards.

Of course this evidence is far from exhaustive but Tily’s book has much more, and I don’t want to flood this post with too many poorly taken photographs.

If macroeconomic policy can have real effects, that blows a significant hole in the arsenal of NGDP target advocates. For whilst most critiques of NGDP targeting focus on how it isn’t feasible, particularly at the ZLB, this one is compatible with its feasibility, but questions its efficacy.

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Governments, Markets and Class (and Libertarians)

The libertarian confusion from me citing evidence that the Chinese government forced peasants off land (and hence de facto into factories) as a criticism of the capitalist mode of production is evidence of a broader problem with libertarian methodology. For while libertarian methodology is supposedly about individuals satisfying their utility maximising preferences, you could argue that, more frequently, libertarians approach things from the perspective of two institutions: ‘governments’ and ‘markets’.

This leads to a lot of problems, not just because governments and markets are regularly framed as opposed to each other, when in fact they are mutually reinforcing when managed right. No, the problem is that, through their governments versus markets lens, libertarians see states throughout history as roughly equivalent. So when I criticise Commie China in an argument against capitalism, how can that work? I’m criticising capitalism, and hence advocating statism, which is synonymous with ‘communism’, which is the opposite of capitalism. So I’ve refuted myself!

For me, this is where marxist class analysis offers the most rich and appealing methodological starting point. We are able to understand the actions of states in their historical context and as distinct from each other. The Social Democratic Scandinavian states have highly successful high tax, high spend policies. On the contrary, the EZ project is an example of massive unrepresentative bureuacracy failing, spectacularly. Now, if we approach this from a ‘governments versus markets’ perspective we’re sort of stuck. Libertarians resort to insisting that Sweden isn’t really that social democratic and does well because of low corporate tax rates and lack of regulation*. Leftists often find themselves trapped on the ‘governments’ side of the equation and as such find themselves reluctant to criticise the state.

But if we approach it from a class perspective, and see the state – slightly glibly, admittedly – as simply advancing the interests of a particular class at any one time, then things make a lot more sense. In the case of Scandinavia, the lower/middle class are exercising their democratic preferences for the distribution income/goods and services, and in the case of the EZ  the political elite/creditor class are trying to allocate as much income as possible to themselves.

There are plenty more examples of governments and markets failing to analyse situations properly – for example, libertarians often cite the fact that the state is in bed with financial institutions as evidence that the crisis was not caused by true capitalism but by the ‘government’ side of governments and markets. Of course this is incoherent; financial institutions neither represent the state or the market, and the best way to describe them is as the elite class – which can include elected politicians, landlords, financiers, and whoever else – rigging the system in their favour.

Another example is the fact that American peasants were not, AFAIK, forced into factories, whilst British ones were. What libertarians might consider two conflicting pieces of evidence are better understood in terms of class: a legitimate democratic state founded on the idea of capitalism in the case of the former, and collusion between the landlords/merchant class imposing capitalism on an unwilling peasantry in the latter. Governments and markets would have trouble dealing with historical events like this.

Libertarians, naturally, have an objection to class because of its association with marxism, collectivism and ‘envy’. But really class is just a far superior tool for analysis. For whilst class representations are inherently collectivist, they are not incompatible with individualist analysis; they can simply be thought of an emergent property, and we can analyse the economy on two different levels, which Libertarians already do with governments and markets. And governments and markets glosses over the institutions required to sustain them, but class is a straight representation of people and so doesn’t take existing legal structures for granted, leading to a less hamstrung analysis. Furthermore, class analysis quickly highlights unjust hierarchies and structures that have been created by current institutions, things that should be rejected by anyone who purports to be in favour of liberty.

*If you follow those links neither of those claims stand up to much scrutiny.

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Libertarianism Versus Public Choice Theory

One of the points on my much maligned third ‘double standards’ post (incidentally, maligners, read these two if you haven’t before) was the following:

10. The state is useless at doing anything. We don’t, however, question its ability to define property and enforce contracts effectively.

as well as this:

4. Historical context matters for gold as a medium of exchange. The historical context of capitalism, however, can be swept under the rug.

This got me thinking: public choice theory potentially blows a massive hole in libertarianism, despite being one of the key components in their arsenal.

The history of capitalism offers a natural experiment in how public choice considerations affect the provision of private property and contracts. To put it simply: the private property has been distributed among a select few who have used it to perpetuate wealth inequalities. Contracts have become infallible to the point where ancient laws/traditions such as laws against usury and debt jubilees are currently unthinkable, politically speaking. Private owners of capital used the state to force peasants – who, in the 14th century, worked about a quarter of hours that the average person does now – to work 12 hour days in factories. Landlords have blocked any attempt to tax away their unearned rents.

In fact, the extent of the collusion between the state and capitalist/rentier class in the provision of private property makes overcharging pharmaceutical companies and mortgage lending GSEs look like childsplay in comparison.

Of course, you can argue against public choice theory on the grounds that politicians aren’t rational self-maximising robots, and do have some sense of public duty. You could also argue from a practical perspective – we need to put institutions in place to combat corruption. But this would be opening the door to all sorts of statist policies.

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Yet More ‘Free Market’ Double Standards

It has gotten to the point where I think ‘free market’ proponents will advocate anything, so long as you frame it to be opposed to the state/Keynes/Marx.

1. Credit expansion causes boom bust cycles, but we shouldn’t use capital controls to prevent this (because liberty).

2. The fact that regulators can be captured means we shouldn’t use them. Similar arguments don’t apply with police and corruption, however.

3. The government should regulate and prevent fraud, but not information asymmetry, which is self-correcting. This is despite the fact that they are the same thing.

4. Historical context matters for gold as a medium of exchange. The historical context of capitalism, however, can be swept under the rug.

5. In a free society, we earn our income. Inheritance? Erm…

6. The best thing for wages and working conditions is full employment, and we can achieve this by getting rid of the minimum wage and regulations. This will increase wages and improve working conditions, but these higher wages and conditions won’t reduce employment in the same way as the regulations did before because free market.

7. There’s no such thing as a free lunch, but perpetual economic growth is a costless path to prosperity.

8. Inflation is caused by too much money chasing too few goods. This doesn’t apply with tax cuts for the rich and positional luxury goods.

9. We must evaluate theories based only on whether they corroborate with empirical evidence. However, I will ignore it when my theories do not.

10. The state is useless at doing anything. We don’t, however, question its ability to define property and enforce contracts effectively.

11. You favour domestic redistribution! You nationalist, look at all the starving people in Africa! What? No, we shouldn’t redistribute to them either.

12. I’m opposed to Keynes. Except I advocate expansionary fiscal and monetary policy, the same as him.

13. The arguments I use in favour of private property do not apply to intellectual property (as well as the inverse).

14. It  matters when the public sector crowds out valuable resources, but not when unproductive parts of the private sector do the same.

15. I’m an anarchist. Except I want corporations to rule the world.

16. Deficit spending on tax cuts for the rich is fine, but not on schools and other bad stuff.

17. I will argue against anti-trust and redistribution, despite advocating them elsewhere.

18. There’s no such thing as a free lunch, but competition always improves market outcomes.

19. Everything is subjective and individualistic. But it doesn’t matter how free people feel, we will use my definition of freedom and impose it on them.

20. Choice, choice, choice. But if a monopoly or cartel arises in the free market, it’s fine.

21. Being made to pay taxes just because you live in a certain territory is unjust. Paying rent is fine, though.

22. We claim the name of Adam Smith, yet neglect to criticise the division of labour, reject worker regulations, banking regulations, active monetary policy and misuse the term ‘the invisible hand‘.

23. We claim the name of Mises, but our views also conflict directly with many of the things he said.

24. I am Mises, and my views also conflict directly with many of the things I’ve said.

Bonus: Many libertarians are also Christians. It is difficult to reconcile these two belief systems.

Happy hunting!

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Why Does Neoclassical Framing Matter?

I have spent a reasonable amount of time focusing on how neoclassical economics frames issues, rather than critiquing it purely from an empirical or logical perspective. I expect the response of some is simply: so what? Framing issues in a certain way can be analytically useful: governments versus markets can help us decide whether a bigger or smaller state is required; presenting information asymmetry and the like as imperfections and studying them one at a time allows for clearer analysis; presenting the economy as a separate entity allows us to approach it from a purely analytical perspective.

Maybe I agree with the sentiment, but my problem is that the way neoclassical economics is framed plays in the hands of the status quo, and thus allows for reactionary and populist rhetoric that will inevitably win the debate, having framed it in the first place. It also affects the behaviour of ordinary people –  any one familiar with reflexivity will agree that the way we model and structure the system will affect how participants behave inside it.

The problem is the whole idea of the economy or ‘market’ as a separate entity, free from legal or historical context, and self-equilibrating, at least in the long run or with a few tweaks. This makes it easy to reject progressive ideas/reform – why would anybody want to tamper with a system like that? It doesn’t matter that the actual conclusions of neoclassical economics – should you study it – are fairly moderate; what matters is the way that certain legislation is presented as interventionist, whilst existing structures are ignored as ‘natural’.

This way of presenting issues appeals to a couple of human biases – firstly, status quo bias; humans have an innate inclination to stick with the current state of affairs and fear change. By presenting the current state of affairs as natural and self equilibrating, this is strengthened. It also interacts with the just world hypothesis – if people’s income is their productivity, if ‘the market’ is formed by people’s preferences whilst the ‘government’ the forcefully imposed on them it is fairer to leave things as they are, as even if the outcomes seem to be unpalatable, they are just.

I have spoken before about how I think presenting the economy as a complex, non-equilibrating system would alter perceptions and help us manage it. Not only this, but I expect it would change the average man on the street’s perceptions. You might think I’m overstating my case, but consider: since the Reagan-Thatcher ‘revolution’, there has been a massive change in social values – people are behaving more selfishly; there is a general idea that the rich and poor are deserving of their lot; work is, in many ways, written off and instead we focus on consumption.

Neoclassical framing strikes me as a damaging way of looking at the world, skewing debate and altering people’s behaviour towards socially undesirable outcomes, and protecting the status quo as some sort of inevitable or natural state (not to mention that neoclassical economics can’t see outside capitalism itself). The government policies that help the rich are hidden, which leads to articles like this, that play into the hands of the wealthy by speaking of ‘managed’ markets versus ‘unmanaged’ ones. Perhaps if our views weren’t so skewed by neoclassicism, it would be obvious that markets are currently managed in favour of the rich.

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Does it Matter if Early Models are Flawed?

One of the central objections to this post was that ‘later’ models incorporate dynamism, and early ones are just introductory, meant to establish basic concepts. I’m not sure this is accurate.

Firstly, are models like supply-demand and IS/LM just introductory? It strikes me that demand-supply is regularly trotted out by academic economists as an argument against the minimum wage and other price controls, while probably the most famous economist in the world has been vehement that IS/LM is all that’s needed to understand our current situation.

Furthermore, ‘basic’ models are all that the overwhelming majority of people ever learn about economics, including many policymakers. If they are that flawed, the correct response isn’t to dismiss 99.9% of the population as ignorant and carry on, but to try and make the basics of economics resemble reality better.

However, neither of these are my main concern with this line of thinking. The problem is that economists regularly make comparisons to physics/engineering, where early models do not incorporate friction, planets are modeled as perfect spheres, etc. I must stress this: economists do not understand the difference between a good assumption and a bad one.

If basic economic models were taught like physics, we would be told the impact of each individual assumption on the analysis, and as things got more complex, we would relax each assumption, one by one. But this isn’t what happens. What happens is that the core of the analysis is kept intact while more epicycles ‘frictions’ are incorporated when reality doesn’t conform to the model. Steve Keen describes this as a ‘dog walking on its hind legs‘ – it can seem to work for a while, but look away and it will return to its former four legged glory.

Keen offers the example of Paul Krugman, attempting to model the crisis within a neoclassical framework:

In what follows, we begin by setting out a flexible-price endowment model in which “impatient” agents borrow from “patient” agents.

Note how the standard ‘banks as intermediaries between savers and borrowers’ model isn’t questioned – instead, it is protected as Krugman attempts to model the crisis ad hoc, a one off due to the ‘patience’ of Chinese people and ‘impatience’ of Americans. The standard neoclassical framework can then be reestablished once the paper is finished.

Why do economists do this? Well, once you start to relax assumptions, models like Arrow-Debreu simply collapse completely. If people are unable to predict the future and hence to model their consumption and production functions based on that, the model just has nothing to say. Thus, to protect the model, we have to ‘add’ rather than ‘take away’ criteria. If relaxing an assumption in engineering meant the entire model collapsed, it would be abandoned.

But, as I said on Daniel Kuehn’s blog, people have this weird cognitive dissonance with economics, a sort of ‘let’s not throw the baby out of bathwater’ mentality despite empirical or logical contradictions. And the funny thing is that the same people don’t apply it to other sciences/social sciences. For me, it feels like defenders of economics are engaged in lengthy special pleading.

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‘That’s OK in Practice, But Does it Work in Theory?’

This is so often mentioned in the context of economics that it is a cliche. However, I thought a list of confused quotes from economists trying to explain how reality is wrong might be both amusing and instructive to the state of the discipline. Most of them speak for themselves, although I’ll offer some comment on the more confused/ing ones.

(1) A commenter on Chris Auld’s blog, on hearing that demand isn’t a ‘law’ because it goes up when stock prices go up:

…simply observing price and quantity data can’t tell us much about the underlying structural relationship. This is a famous identification problem in economics. The law of demand is a statement about the structural relationship, not the observed correlation in the data.

(2) Preston McAfee and John McMillan, expressing incredulity when confronted with evidence from surveys that people behaved ‘irrationally':

Statements about the winner’s curse come close to asserting that bidders are repeatedly surprised by the outcomes of auctions, which would violate basic notions of rationality.

(3) Scott Sumner, defending the EMH:

I know of no explanation for the 1987 bubble.  The collapse (comparable to 1929) occurred when the overall economy was doing fine.  Some argue for “computer trading,” as if computers have free will.  I am not saying they are wrong, but then the correct term would be “really stupid computer programmers.”  If correct, this is a good argument against the EMH position.  But even here, one must be careful not to push things too far.  At the time EMH opponents probably assumed more than just a inexplicable price change—they probably assumed that the bubble’s peak represented irrational exuberance.  Were stock prices too high before the 1987 crash?  We had no way of knowing then, and we still don’t really know.  There is enormous uncertainty about what the stock market should be trading at, based on “fundamentals.”

Reality doesn’t exist! We don’t know anything! Anyway, where was I? Oh yeah, the EMH is correct.

(4) Scott Sumner, on hearing that MMT actually *gasp* looks at the real world:

I wasn’t able to fully grasp how MMTers (“modern monetary theorists”) think about monetary economics (despite a good-faith attempt), but a few things I read shed a bit of light on the subject.  My theory is that they focus too much on the visible, the concrete, the accounting, the institutions, and not enough on the core of monetary economics, which I see as the ‘hot potato phenomenon’.

(5) A commenter at Angry Bear, when presented with evidence that flat out contradicts the Laffer Curve:

Mike can not do a comparison with what the Laffer Curve is doing. Its Apples and Oranges. The Laffer Curve is a realtionship, thats why there is no numbers on it, and it can applied at any point in time. 

Unfalsifiable. Gotcha.

(6) Ben Bernanke, discussing Irving Fisher’s ‘Debt-Deflation’ theory:

Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.

Of course, it’s not possible the banking system works completely differently to your theory.

(7) Eugene Fama, with the best defense of the EMH I have ever seen:

Fama: I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.

…what happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.

John Cassidy: Surely the start of the credit crisis predated the recession?

Fama: I don’t think so. How could it? People don’t walk away from their homes unless they can’t make the payments. That’s an indication that we are in a recession.

(8) And of course, the classic: Milton Friedman in his reality denying essay:

The articles on both sides of the controversy [regarding marginalist analysis]…concentrate on the largely irrelevant question of whether businessmen do or do not in fact reach their decisions by consulting schedules, or curves, or multivariable functions showing marginal cost and marginal revenue.

How does neoclassical economics instill this level of cognitive dissonance in people?  It’s probably the way things like information asymmetry and irrationality are presented as deviations from idealised conditions, rather than as being central to an understanding of the economy. This leads economists to see reality itself as a deviation from their perfect models, and hence dismiss results that conflict with their theories as anomalies.

So a question for defenders of economics: do people from other disciplines behave similarly? Would you be able to find a list of equally absurd statements from other sciences, social or otherwise? If the answer is no, surely it suggests that something is wrong with economics?

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Are Static Neoclassical Models Useless?

If somebody presented you with a static snapshot of weather patterns, it would be clear that the model was fairly useless; as it didn’t capture dynamics, it would have nothing to tell you about the weather. Similar problems apply to neoclassical models: once you attempt to incorporate dynamic events, they don’t just become ‘wrong’, they become completely irrelevant.

Comparative Advantage

I posted recently about how CA is irrelevant for developing countries, but I’d like to expand: it is completely irrelevant for arguments about protectionism. The problem is that if you take into account the effects of tariffs on the productivity of the industries they are aimed at, it has nothing to say – not just for developing countries, but for any industry whatsoever. CA assumes that every country has an innate productive capacity in each industry that does not change over time. If you froze the world, CA might be a persuasive argument for free trade, but in a dynamic economy it completely irrelevant.

Supply-Demand

Say the price of a necessity goes up due to a supply shortage. Modelling this as a simple ‘price increase’ suggests that demand would go down. However, if people are expecting the supply shortage to continue or worsen, then isn’t it more probable that demand will go up? Mainstream economists might have an answer: the price increase can be modelled as a movement of the supply curve, whilst the new information about the supply shortage can be modelled as a movement of the demand curve:

(D1 to D3, S1 to S2)

Problem solved. Except this movement of the demand curve leads to a higher price, which in turn would cause people to alter their expectations of the shortage, leading to another movement, and so forth. This may be a highly specific example, but it touches on a central Sraffian criticism of these models, which is that the curves cannot move independently; a change in one creates ripple effects that violate ceteris paribus. Thus, taking a picture of the state of them at any one time tells you as much as a photo of a moving train tells you its velocity.

IS/LM

Both ‘curves’ are partially derived from expectations – one from expectations of returns on investments, and one from expectations of future needs for liquidity. Therefore, a similar criticism to Demand-Supply applies – movement of one curve alters expectations and so affects the other. This creates a feedback loop that simply cannot be captured by two intersecting curves. At any one moment, the diagram might be said to be ‘right’ (putting aside other objections), but this doesn’t mean it is useful.

I expect economists won’t appreciate a whistle-stop tour of their models that claims to have debunked them, but at the same time I expect they’d agree that the above ‘weather’ example would so obviously flawed that it would not need to be refuted formally. In order to avoid special pleading, economists will have to argue that the economy is at or close to equilibrium, rather than a dynamic system. I do hope nobody claims this after 2008 (or the recurrent crises for centuries before that).

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Cutting Taxes on the Rich Causes Inflation

James Kroeger has an interesting website that puts forth some unique arguments, particularly in favour of progressive taxation. The thrust of Kroeger’s argument is as follows:

When individual lottery winners collect their millions, they enjoy a dramatic increase in their purchasing power.  Suddenly, they are able to make a claim on the scarcest goods & services that the economy makes available.  But what if our politicians in Washington were to decide one day to simply hand out a million dollars to every household in America?  We’d all be able to share the same great experience of luxury living then, wouldn’t we?  Well…no.

By re-framing marginal tax cuts as simply ‘giving’ rich people a certain amount of money, he exposes somewhat of a right wing contradiction: though RWers are often keen to scream inflation when money is doled out, they do not seem to hold the same opinion when the money is doled out to the rich. Now, you might say that taxed money doesn’t disappear; it is spent on other things, and this is true. However, if we consider the ‘Cantillion‘ effects of the distribution of spending, we might expect there to be more of a problem as the goods and services purchased by rich people become more esoteric.

I’d also like to add something to Kroeger’s thesis. As marginal tax rates decrease, people will be more inclined to ask for pay rises, as they have more to gain. If, for example, marginal tax rates were actually lower than the ones that preceded them, we’d be highly likely to experience higher wage inflation (and therefore higher general inflation).

Ultimately, of course, it is an empirical question whether cutting marginal tax rates simply inflates the price of luxury goods, thus benefiting noone but damaging the public purse. So what has happened to the price of luxury goods over the last 30 or so years, when marginal tax rates have done this:

For comparison, Forbes have an incredibly useful ‘Cost of Living Extremely Well Index’, which is shown along with the CPI here:

Clearly, the relative price of luxury goods has taken off as marginal tax rates have plummeted. Now, I don’t want to infer correlation-causation, but this seems like evidence for Kroeger-Unlearningecon effects (!), and I am having a hard time coming up with other explanations for the CLEWI rise.

But perhaps I just have a bias in favour of my new hypothesis.

Addendum: If anybody has any further evidence that is relevant to this argument, I’d be grateful.

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